Essential Corporate News
On October 27, 2020 the Code Committee of the UK Takeover Panel (Panel) published PCP 2020/1 (the Consultation) setting out a number of wide-ranging proposed changes to the UK Takeover Code (Code).
The Corporate Insolvency and Governance Act 2020 (CIGA) entered into force in the United Kingdom this summer, amidst the economic and social disruption caused by the COVID-19 crisis. The reforms enacted by CIGA represent the most wide-ranging amendments to the UK corporate insolvency framework for a generation.
We are beginning now to see instances of UK and non-UK debtors actively considering and seeking to avail themselves of the new procedures and protections available following CIGA in evaluating and implementing their restructuring options. Norton Rose Fulbright has recently represented a significant creditor in the restructuring of Virgin Atlantic, which is the first example of the use of the new scheme of arrangement introduced by CIGA. This article provides a timely overview of the main CIGA reforms and reaches some conclusions about the utility of the reforms for UK and non-UK debtors.
There are two main features of CIGA:
The short-term measures had been due to expire on September 30, 2020, under CIGA as originally enacted. The restrictions related to statutory demands and winding-up petitions were extended shortly before that deadline to December 31, 2020, so that creditors cannot rely on statutory demands to bring winding-up petitions before the end of the year, and are prohibited from filing winding-up petitions where the company’s inability to pay is due to COVID-19. There has been no equivalent extension of the wrongful trading dispensation, which—since it went to the award the court is able to make on a successful claim by an insolvency office-holder, rather than liability as such—provided little comfort to directors in any event.
The focus of this article is the permanent measures falling in the second category above, as follows:
These measures have each featured in consultations on insolvency law reform in the UK in recent years. Their introduction by CIGA has been expedited by the COVID-19 crisis and the legislation passed through Parliament very quickly. The moratorium and essential supplies provisions are facilitative provisions, to be used in conjunction with other restructuring steps. The Super-scheme is different, in that it provides a non-prescriptive and flexible framework for an all-encompassing restructuring of specified claims against a company (in-keeping with existing scheme of arrangement provisions in the Companies Act).
Each of the measures will be addressed in turn.
The new moratorium is a free-standing process intended to serve as a gateway for debtor companies to further restructuring steps. Since its introduction by CIGA, the moratorium has featured widely in discussions with companies and management around available measures and relief in response to financial difficulties caused by COVID-19, but it has not yet been widely used in practice.
It is comparatively easy to access—in a straightforward case for an English company, the company can enter the moratorium by its directors filing prescribed documents at court. In this sense, it is similar to an administration moratorium. The scope of the moratorium, too, is similar to that which applies in administration. The main difference is that, unlike administration, the new moratorium is primarily a “debtor-in-possession” procedure, in that the directors of the company retain ordinary-course management powers, albeit it does entail the appointment of a monitor (who, in practice, will normally be a qualified insolvency practitioner). It follows that the directors’ duties and responsibilities to creditors and other stakeholders continue throughout the moratorium.
The moratorium is intended to be used by debtor companies in financial distress where there remains a realistic prospect of survival. It permits eligible companies (excluding, for example, financial services-related companies) in certain circumstances to obtain a moratorium for an initial period of twenty business days (and extendable for up to a year, subject to conditions), giving them various protections from creditors and a payment holiday from certain debts falling due prior to the moratorium and during the moratorium (excluding, amongst other things, debts under financial services contracts and rents under leases, which remain payable). The intention is to provide an optional statutory breathing space from creditor actions in order to allow the debtor to formulate a turnaround strategy.
Although the moratorium involves the appointment of a monitor, day-to-day management decisions will continue to be exercised by the existing directors of the debtor. It is hoped that the debtor-in-possession nature of the procedure will mean that fewer directors are discouraged from having recourse to the protection available under the moratorium than has been the case historically with administration—which continues sometimes to carry a connotation of management failure. The monitor is responsible for the protection of creditors’ interests and to ensure that the debtor continues to comply with moratorium eligibility requirements and conditions. In order to qualify for the moratorium, the papers filed at court in order to commence the process must contain a statement given by the proposed monitor that contain a statement from the proposed monitor that, in their view, it is likely that a moratorium for the company would result in the rescue of the company as a going concern. The monitor is able to attend board meetings and request information from the directors required for the performance of their functions. Further, the monitor is responsible for sanctioning any non-ordinary course of business transactions, as an additional safeguard for creditors.
The moratorium is available to UK companies in most cases by an out-of-court entry-route, and to non-UK companies with a sufficient connection to the UK through making an application to court (subject to conditions).
Although, on its face, the moratorium appears to be attractive as a means of “holding the ring” pending the formulation and implementation of definitive restructuring steps, the process in its current form has a number of limitations which are likely to limit its use in practice, including the following. First of all, it has to be questioned whether the initial four- or eight-week period will be sufficient to formulate a restructuring proposal. This suggests that “open-ended” or “free-fall” moratorium filings will be uncommon; rather, it will be preferable, if using a moratorium at all, to ensure a certain degree of creditor support for a filing and underlying restructuring plans. Secondly, in that regard, the exclusion from the payment holiday of debts under financial services contracts means that a moratorium will not be sustainable with the support of financial creditors, since, otherwise, those debts must continue to be paid as usual and the commencement of the moratorium would likely trigger an event of default under standard insolvency proceedings-type events of default. Finally, the eligibility criteria for a moratorium exclude companies that are a party to a capital market arrangement. This is defined broadly, and basically includes any company which is part of a group that has issued bonds or notes; clearly, this will limit considerably the numbers of eligible companies.
The new restrictions ensuring continuity of supply of goods and services are intended to help foster an environment that is more conducive to achieving a corporate rescue properly so-called than has historically been the case in the UK. The new Insolvency Act provisions introduced by CIGA prohibit the termination of any contract for the supply of goods and services to a company or the occurrence of terminate or “any other thing” under the contract by reason of the company entering into a relevant insolvency procedure (including the new moratorium, administration, a company voluntary arrangement and the new Super-scheme but not an ordinary (or Part 26) scheme of arrangement). Unsurprisingly, “any other thing” is not defined, but it is likely to include increases in interest rate consequent on entry into relevant insolvency procedures or the changing of the terms of the supply.
In the past, it has all too often been the case that insolvent debtors have been held to ransom by threats of termination by suppliers of the improvement of terms of supply and payment of pre-insolvency arrears as conditions of continued supply of goods and services. Under the new provisions, suppliers must continue to supply the debtor in an insolvency or restructuring process and are not guaranteed payment of outstanding arrears.
If the debtor ceases to pay for goods or services during the insolvency procedure, this will normally give rise to a termination right exercisable by the supplier. Otherwise, where the provisions apply and the debtor requires continued supply, a supplier will only be entitled to terminate where the court gives termination on the basis that the obligation to continue to supply is causing hardship to the supplier. “Hardship” is not defined in the new provisions; it is expected that its meaning will be explored and clarified in cases over the coming months and years.
The prohibition applies to supply contracts for goods and services, although there are wide-ranging exceptions to the prohibition, including in the case of persons involved in financial services (whether they are the company or the supplier) and contracts involving financial services. The effect of these exclusions is that lenders are not precluded from exercising rights to draw-stop facilities or accelerate loans.
Inevitably, many queries we have received from suppliers whose contracts may fall within the prohibition have related to introducing termination events vis-à-vis counterparties into contracts which are triggered at an earlier stage than commencement of specified insolvency proceedings. Another widely-mooted “work-around” is the use of shorter-term contracts, perhaps under the auspices of a wider framework agreement. Paradoxically, the use of such measures may lead to the scuppering of the survival chances of businesses encountering modest levels of distress, if there is a perception on the part of suppliers that a continued business relationship will lead to them becoming “locked in” and unable subsequently to exercise termination rights if the plight of the debtor worsens.
The new Insolvency Act provisions do not specify whether the protections on supplies apply to all contracts to which the debtor is a party or only English law-governed contracts. Presumably, the former is intended but this is likely to give rise to complex conflicts of law questions in practice.
The new Super-scheme provisions in Part 26A of the Companies Act are largely based on schemes of arrangement under Part 26 of the Act, as commonly used by UK and foreign debtors to effect financial restructurings over the past decade or so. However, unlike with an ordinary scheme (which have no “entry criteria”), in order to be eligible the debtor proposing a Super-scheme must be facing current or anticipated financial difficulties. In addition, the voting requirements for a Super-scheme are more straightforward; it requires the approval of only 75 per cent by value of each class of shareholders and/or creditors (subject to the below), whereas an ordinary scheme requires 75 per cent by value and a majority in number in each class of shareholders and/or creditors.
The most noteworthy feature of Super-schemes is the ability to effect a “cross-class cram-down” using the process. Whereas, under an ordinary scheme, consent is required from the relevant majorities in each affected class, under a Super-scheme, creditors within a class that votes against the Super-scheme can nevertheless be forced to accept the plan if: (a) at least one class of creditors with a genuine economic interest voted in favour of the plan; (b) the creditors in the dissenting class would not be any worse off under the Super-scheme than they would have been in the relevant alternative scenario; and (c) the court considers the Super-scheme to be fair. The “relevant alternative” is the outcome the court considers would be most likely to occur in relation to the company if the Super-scheme were not sanctioned. The concepts of “genuine economic interest” and the “relevant alternative” are likely to be the most contentious aspects of Super-schemes. They will likely draw English judges into determining commercial issues and matters of valuation (as matters to be addressed through expert evidence) which they have traditionally steered clear of – particularly when compared with judges in the US Bankruptcy Court. This will be all the more so when the debtor seeking to implement a Super-scheme is a non-UK debtor, since, in that event, the relevant alternative is less likely to be a UK insolvency process; rather, such cases will invariably involve grappling with estimated outcomes for different creditor groups and shareholders in foreign insolvency and/or corporate recovery processes.
Some commentators have focused on the potential under a Super-scheme for a “cross-class cram-up”; in other words, a situation in which classes of junior or unsecured creditors might seek to impose a plan on a class or classes of dissenting secured creditors, assuming the above tests are satisfied. It would be highly surprising in the current restructuring environment—where high levels of support are customarily assured in advance through the use of “lock-up” agreements—if secured creditors who are not supportive of a Super-scheme proposal were to refrain from exercising their rights of enforcement for long enough for their wider rights to be compromised in this way (and, separately, for the court to exercise its discretion to sanction a Super-scheme in such a case).
Even though Super-schemes are intended for use by companies experiencing financial difficulties, they are unlikely now—prior to the end of the Brexit implementation period— to be designated in Annex A to the EU Regulation on Insolvency Proceedings as a relevant type of insolvency proceedings for the purposes of the Regulation. Accordingly, they will not benefit from automatic recognition under that Regulation. It remains to be seen whether Super-schemes for non-UK debtors will be recognised across the European Union post-Brexit. In practice, this has rarely been an issue for ordinary schemes and other member states have readily recognised and given effect to schemes. We expect that the same will be true in respect of Super-schemes, but the position is far from clear. Significantly, in this respect, the English court must be satisfied in determining whether or not it has jurisdiction to sanction schemes and Super-schemes alike that they will achieve a substantial effect in key non-UK jurisdictions.
As noted, Virgin Atlantic, the airline, has recently successfully implemented a Super-scheme (the English court sanctioning the Super-scheme on September 2, with recognition in the US under Chapter 15 of the US Bankruptcy Code following shortly afterwards, on September 3). Both judgments handed down in the course of the passage of the Virgin Atlantic Super-scheme through the approval process—following the “class-convening” and sanction hearings—are instructive to the approach the court will take going forward on matters of procedure and issues like class constitution. However, it is fair to say that the Virgin Atlantic scheme did not truly test the parameters of the kinds of restructurings possible using a Super-scheme. Of the four classes of creditors, three had agreed prospectively, through lock-up agreements (or, in this case, “support agreements”), to vote in favour of the Super-scheme, leaving only one class, a select group of trade creditors, whose vote could not be wholly assured at the time of the class meetings. In the event, 99% of the trade creditors attending and voting at the relevant class meeting voted in favour of the Super-scheme. Accordingly, while a resounding success in terms of the level of creditor buy-in, the Virgin Atlantic Super-scheme leaves untested issues such as cross-class cram-down and related considerations. A further point is that, since all operating lessors voted in favour of the Super-scheme, the court was not required to consider whether a Super-scheme qualifies as “insolvency proceedings” for the purposes of the International Interests in Aircraft Equipment (Cape Town Convention) Regulations 2015 (the effect of so qualifying being that it would not be possible to modify the obligations of the airline under leases without the consent of the relevant lessors).
CIGA marks an ambitious shift towards more debtor-led restructurings and the pursuit of corporate rescue, and seeks to address some of the perceived shortcomings of existing insolvency proceedings in the UK including the loss of control by management and the ability (historically) of suppliers freely to rely on contractual rights of termination once insolvency proceedings commence.
In particular, CIGA has adopted some features similar to those that contribute to the strong track-record of Chapter 11 of the US Bankruptcy Code for effecting corporate restructurings – notably, the provisions restricting termination of supply contracts, which have close parallels to the prohibition under Chapter 11 on enforcement of ipso facto clauses. However, it must be remembered that there remain crucial differences between insolvency systems on either side of the Atlantic, including the degree of court involvement (which remains much more extensive in the US) and the ease of access of super-priority new money to fund a restructuring process. The latter point is something that has featured in recent UK corporate insolvency reform consultations but was not pursued in the last Government consultation response prior to COVID-19 or indeed in CIGA itself.
Further, closer examination of the moratorium and essential supplies provisions introduced by CIGA—and the wide-ranging exceptions thereto—reveals a focus on restricting rights of trade creditors and suppliers, which suggest that they will have most practical use in the restructuring of small to medium-sized enterprises. Although the flexibility and breadth of the new Super-scheme is attractive and opens up new possibilities for UK-centred restructurings, there is a concern that the cost and typical gestation period for a scheme of arrangement—typically 8 to 12 weeks—might remain out of reach of large numbers of corporates in need of immediate rehabilitation.
It remains to be seen whether the attempt by the UK, in enacting CIGA, to align itself with more debtor-friendly systems will in fact achieve the desired aim of increased instances of corporate rescue and value-preservation. So far, official formal insolvency figures during the COVID-19 era have been relatively benign, but that has more to do with the CIGA short-term restrictions on winding-up petitions and Government support initiatives for corporates than the permanent CIGA reforms considered in this article. It will be interesting to gauge the impact of the restructuring-focused measures of CIGA in the coming months—including the appetite of non-UK debtors to seek protection in the UK. This is especially the case with the end of the Brexit implementation period looming at the end of 2020 and continuing EU member states legislating to implement and shore up their own restructuring processes in transposing the EU Restructuring Directive into national law by July 2021.
On October 27, 2020 the Code Committee of the UK Takeover Panel (Panel) published PCP 2020/1 (the Consultation) setting out a number of wide-ranging proposed changes to the UK Takeover Code (Code).
During the past few days, the Mexican government has issued international public tenders for the award of 2 major public private partnership (PPP) water projects in Los Cabos, Baja California Sur.