In recent years, the UK Government has consulted on, inquired into and produced a number of reports on issues relating to insolvency and corporate governance, and their reform. Some of these considerations were proactive, while others were reactive, primarily to a series of high profile corporate failures in the UK in recent years.
Among those reports, consultations and inquiries, of central importance were the consultations launched in May 2016 (which focused on the options for reform of the UK insolvency framework) and March 2018 (in which emphasis was placed on insolvency and corporate governance) (the "Consultations").
On 28 August 2018, the UK Government published its responses to the Consultations (the "Response"), setting out its proposals for reform and, where relevant, its suggestions for further contemplation and deliberation. While the timeline for implementation is unclear, these proposals arguably constitute the largest overhaul of the UK corporate insolvency framework in almost 20 years.
The 2016 Consultation: increasing protections for creditors and achieving a fairer balance
The 2016 Consultation was seen by some to be the UK Government's response to the fall of the ranking of the country's corporate insolvency framework in a World Bank league table. That decline came as a result of the attribution in that table to higher scores for debtor-in-possession pre-insolvency procedures – which the UK regime notably lacked (and continues to lack). Consistent with that emphasis, the 2016 Consultation made a number of proposals for reform to the UK corporate insolvency regime, on which views were sought, and those views have shaped part of the Response. These aspects of the reforms will, the Response suggests, be legislated for when Parliamentary time permits; although precisely what that means, or will mean in practice, is unclear, given the looming Brexit deadline and the related preoccupation of the legislature and the executive.
Key are the following:
- A new pre-insolvency moratorium
The UK Government proposes to introduce a pre-insolvency moratorium, which would prevent creditors taking enforcement action against a company while it considers its rescue options.
Under existing UK insolvency law, a company must first enter administration (a formal insolvency process in which an administrator takes control of the company from the directors) before such relief can be granted. This new pre-emptive moratorium would be a way to give a company, and its directors (who would remain in control of the company during the moratorium), the necessary "breathing space" to work through their options with a view to preserving value and jobs. Anticipated outcomes from the moratorium would be either an agreed informal restructuring or entry into a formal rescue or insolvency procedure.
In order to seek the protection of the moratorium, a company would need to demonstrate prospective, but not actual, insolvency, and would need to have legitimate reasons for seeking its protection. Companies that are already insolvent would not be eligible to access the moratorium. These tests are designed to ensure that directors do not mis-use the moratorium to delay an inevitable insolvency.
A moratorium would be triggered by filing papers at court (akin to the current process for appointing an out-of-court administrator); a court process or hearing would not be required.
A moratorium would initially last for 28 days. It could be extended for a further 28 days if the monitor (being the individual appointed to oversee the moratorium) considers it appropriate. If a further extension beyond 56 days is sought, that would have to be approved by creditors, with the required thresholds for approval being more than 50 per cent of secured creditors by value and more than 50 per cent of unsecured creditors by value. Application could also be made to the court to extend a moratorium if seeking creditor consent is "impracticable".
It would be possible for creditors to challenge the moratorium - either because they considered that the company did not meet the qualifying conditions or because the moratorium would cause unfair prejudice to creditors.
It is also important to note that the new moratorium would not replace the options which currently exist for a restructuring in the UK, so it would remain open to a company to, for example, negotiate standstill arrangements with its creditors without using the moratorium.
- A new cross-class standalone "rescue plan"
It is also proposed that a new cross-class standalone restructuring procedure would be introduced, which would be available to solvent and insolvent companies (including those in formal insolvency processes), without financial entry criteria.
The voting threshold would require 75 per cent in value (measured by value of gross debt) of the creditors who vote in each class to vote in favour of the plan. Dissenting classes of creditors would be bound by the plan if it is in the best interests of all stakeholders. In order to safeguard creditor interest, the rescue plan legislation would provide that a dissenting class must be satisfied in full before a more junior class can receive any distribution (the "absolute priority rule"), although it is proposed that the court could confirm a plan even if this requirement is not met, if non-compliance is necessary to achieve the restructuring's aim and it is just and equitable to do so in the circumstances.
Procedurally, what is proposed would largely follow the current practice for UK schemes of arrangement: there would be a proposal sent to creditors and shareholders which is filed at court, a convening hearing where class composition would be considered by the court, with a vote then taken and a second "sanction" hearing.
A key theme running through this proposal is that a company should be given "maximum flexibility" over the terms of, timing, and implementation of its proposed plan: prescription by the UK Government as to what a proposal must involve would be minimal, and the Government has opted not to require the appointment of a plan supervisor, preferring to leave each company to decide on its preferred approach.
- Ipso facto clauses to be unenforceable
The Response also states that the Government will legislate to render unenforceable contractual clauses which allow suppliers of goods and services to terminate those contracts upon counterparty insolvency. This prohibition would be available to prevent third parties from terminating their contracts solely as a result of a company seeking the protection of the new moratorium, or upon its entry into a formal insolvency procedure or proposal of a new "rescue plan".
Suppliers would therefore be required to continue to fulfil their commitments to the debtor company. The Response suggests that there will be an exemption for certain types of financial products and services, yet is not specific on what, exactly, will be covered by that exemption. The Response is also not clear on whether an equivalent restriction on customer's terminating would be introduced. These aspects will need to be worked through as this reform approaches the statute book.
Preventing Carillion and BHS repeats
Recent years have seen the demise of a number of UK companies. Most notable amongst them were the 2016 collapse of BHS, a high street retailer, shortly after the company was sold for £1, and Carillion, which entered liquidation in January 2018.
The 2018 Consultation sought views on the ways in which the likelihood and impact of major corporate failure might be mitigated, which are considered in the Response. Unlike the moratorium, restructuring plan and ipso facto proposals – which the Response makes clear will be legislated on (albeit it that it is not entirely clear when that will be) – the remaining aspects of the reforms will require further consultation and deliberation; as a result, their implementation is likely to be even more protracted.
The central aspects of these reforms are:
- Prevent trading into disaster or a "Carillion repeat"
While not wishing to deter lenders from supporting restructurings, the UK Government is concerned to ensure that those who seek to unfairly extract value from distressed companies are deterred from doing so. In the Response, examples of "value extraction" schemes are given, including charging "excessive" interest on loans and repayment of debt to an investor in preference to other creditors. The Government's intention is to enhance the existing recovery powers of insolvency practitioners as a means to deter such value extraction, and it intends to consult further with stakeholders on how best to achieve this.
The Government also intends to extend existing powers to allow for the actions of former directors of dissolved companies to be investigated, with the aim of ensuring that directors of distressed, or potentially distressed, companies, properly consider their actions.
- Prevent plunder or a "BHS repeat"
The Response is clear that certain of the Government's proposed reforms are designed to ensure that directors of companies which are in, or approaching, insolvency, meet the standards that are required of them. The Government is focused on learning lessons from recent corporate failures which have seriously impacted customers, suppliers and employers by strengthening corporate governance in pre-insolvency situations.
In particular, it is proposed that measures will be introduced to ensure greater accountability of directors of companies which are selling distressed subsidiaries. When selling a distressed subsidiary, directors would need to have a reasonable belief that the sale would likely deliver a no worse outcome for the stakeholders of the subsidiary than placing it into a formal insolvency. However, the Government is clear that any such measures should not disincentivise rescues or render directors unnecessarily liable for the conduct of others over which they have no control.
The Response also outlines that further consultations and analysis will be required in order to enhance pre-insolvency corporate governance. There is a focus on increasing transparency requirements for groups with complex structures and enhancing director training, to strengthen board effectiveness.
What does this all mean?
While the Response sets out the UK Government's proposals, and proposed next steps, in response to both Consultations, it does not suggest, or set out, a clear timeline for implementation of its proposals in connection with either of the Consultations.
As regards the reforms proposed in connection with the 2016 Consultation – the moratorium, the plan and the prohibition on ipso facto enforcement - the Government intends to introduce new implementing legislation as soon as Parliamentary time permits. Precisely what that means, however, is unclear. The scope for introduction of non-Brexit legislation (not least its deliberation and entry into force) is incredibly limited, and will continue to be for some time.
At this stage, while the timing for implementation remains unclear, what is clear is that change is coming.