The Corporate Insolvency and Governance Act 2020 (the “Act”) came into force in June 2020. It introduced a number of temporary and permanent measures to restructuring and insolvency law which will affect creditors’ rights in the UK. The overarching objective of the Act is to promote the rescue of companies in financial difficulties by introducing a new “moratorium” procedure, a new “restructuring plan” procedure and new rules prohibiting the termination of contracts for the supply of goods and services by reason of insolvency (so called “ipso facto” clauses). The Act represents the biggest change to insolvency legislation in 20 years and has implications for:
- Supply chains
- Construction works
- Project finance
For a general explanation of the Act, please see our full briefing note The UK Corporate Insolvency and Governance Act 2020
Key points for project finance transactions
We explore the implications for the Act in the context of project finance transactions in detail below. Key points to note are:
- The Act introduces a new “moratorium” procedure which will allow eligible companies to continue to trade whilst having the protection of a stay which prevents creditors from taking enforcement steps against them. The moratorium is a rescue process intended to give the company a breathing space to allow time to implement a rescue plan. It is not an insolvency process. The moratorium is not available to various categories of companies including a project company in a public-private partnership project (PPP) or to companies which have entered into a capital markets transaction (such as the issuing of bonds) which involved the incurring of debt of at least £10 million, but otherwise a project company in a project finance transaction is likely to be eligible and able to use the procedure.
- There is a payment holiday during the moratorium for all pre-moratorium debts other than in relation to six categories of excluded debt, which include debts payable under financial services contracts. These include loans, leases and guarantees and commodities contracts (see further below) and so will include debt provided in a project financing.
- The moratorium will be available to a project company’s supply chain but would not restrict enforcement of credit support provided by a third party such as a enforcement of a bond, letter of credit or guarantee, provided that that third party itself was not in a moratorium. As a result this security would still be available, despite the moratorium over the company in the supply chain, to support performance, delay and/or rejection rights under the project contract.
- The Act introduces prohibitions on the effect and use of ipso facto clauses where the company receiving the supply is subject to an insolvency or restructuring procedure. As a result, where the project company is solvent and in receipt of the supply under a project contract, the Act does not restrict termination of the supply contract by the project company by reason of the supplier’s insolvency. However it is important to check whether the project company, as employer, might be providing any ancillary supplies to the insolvent supplier which may be caught by the Act.
- By contrast, where the project company is itself providing the supply under an offtake agreement to an offtaker which is subject to a relevant insolvency procedure, the prohibition on ipso facto clauses may apply, and the project company required to continue to supply, unless an exclusion applies. Certain categories of supplier and categories of contract are excluded. In particular, the new rules do not apply to “financial contracts”, which include certain “commodities contracts”. However there is no definition of what the excluded commodities contracts include is not defined within the Act and will therefore be likely to be tested in case law in the courts.
- There may be unexpected consequences with regard to the operation of direct agreements and collateral warranties that will require careful consideration.
Key aspects of the Act
In this section, we consider the implications of the three permanent changes to insolvency and restructuring law set out in the Act, namely:
- The new moratorium and its effect
- Termination clauses
- The new restructuring plan
We will then consider implications of the Act on construction works, projects and project finance arrangements.
(1) The moratorium and its effect
Who can use the procedure?
The moratorium is a new standalone procedure (which is not an insolvency procedure) which gives the directors of a company the ability to apply to the court for a moratorium to give the company protection from creditors while implementing a rescue plan. During the moratorium process, the directors remain in control of the company but a “monitor” (who is an insolvency practitioner) is appointed to monitor the company’s affairs to check that the company is making the payments it is required to make in the moratorium and to keep under review whether it remains likely that the moratorium will result in the rescue of the company as a going concern.
The directors are required to file a number of documents at court to commence the procedure, including a declaration that the company is, or is likely to become, unable to pay its debts and a statement from the proposed monitor that a moratorium would be likely to result in a rescue of the company as a going concern.
Some companies are not eligible to use the moratorium procedure, such as banks, insurers, PPP project companies and companies which have entered into a capital markets transaction (such as the issuing of bonds) involving debt of at least £10 million.
The moratorium procedure is available to an overseas company if it has a sufficiently close connection to England and Wales. For example, a holding company incorporated abroad might be eligible by virtue of holding shares in a project company incorporated and doing business in England, particularly if it carried out no other business.
From a UK infrastructure perspective, any project company in a PPP and that includes step-in rights is excluded. PPP is widely defined as a project (a) the resources of which are provided by one or more public bodies and partly by one or more private persons, or (b) which is designed wholly or mainly for the purpose of assisting a public body to discharge a function. A public body means any body which exercises a public function or has been specified by regulations and the resources which may be provided range from funds to professional skill. Special administration rules often apply in relation to particular public sector projects such as rail, water, energy, social housing, and further education which would include oversight also by an appropriate public body.
What are creditors prevented from doing during the moratorium?
During the moratorium, creditors are prohibited from commencing insolvency proceedings against the company so they are unable to:
- Petition to wind up the company; or
- Apply to put the company into administration.
Creditors are also unable to take the following steps against the company without the permission of the court:
- Enforcing security other than in relation to financial collateral (see below)
- Repossess goods or premises
- Commencing or continuing a “legal process” (save for some types of employment proceedings)
- Enforcing a judgment
- Taking steps to crystallise a floating charge
The phrase “legal process” is used in relation to the statutory stay which comes into force upon a company going into administration and has been held to include adjudications of construction disputes under s.108 of the Housing Grants, Constructions and Regeneration Act 1996.
Can share charges be enforced during the moratorium?
Lenders are able to enforce collateral security charges or security created under a financial collateral arrangement notwithstanding the moratorium. This means that even if the company holding the shares in the project company goes into a moratorium, enforcement of the charge over shares in the project company would still be possible.
What payments does the company have to make in the moratorium?
During the moratorium, the company has a payment holiday in respect of all pre-moratorium debts that have fallen due prior to the moratorium. That payment holiday continues during the moratorium in relation to amounts which fall due during the moratorium other than in relation to six excepted categories. These categories include amounts that fall due during the moratorium and are amounts payable in respect of:
- Goods or services supplied during the moratorium
- Rent in respect of the moratorium period
- Wages and salaries
- Liabilities arising under a contract involving financial services (such as a bank loan, finance leasing agreement or bonds)
From an energy and infrastructure perspective, it is important to note that there are no payment holidays during the moratorium for debts or other liabilities payable under financial services contracts which include loans, leases and guarantees and commodities contracts (see further below) and so will include debt provided in a project financing.
Lenders are able to exercise contractual rights during the moratorium, for example, to accelerate a loan. This would mean that the full amount of the loan would fall due and would be likely to result in the termination of the moratorium by the monitor as the company would be unable to pay the amount due. As a result, in practice, companies are likely to need to secure the support of their lenders before seeking to use the moratorium procedure or immediately following the entry into the procedure.
What is the role of the monitor and what happens in the moratorium?
The proposed monitor has to file a declaration that the company is eligible for the procedure and that in his/her view, the moratorium would be likely to result in the rescue of the company as a going concern. The moratorium is initially for a relatively short period of 20 business days, extendable to 40 business days by the directors on a further application to the court (provided that the monitor confirms that the debts payable in the moratorium have been paid and the rescue is still likely). The moratorium can then be extended for up to a year with the majority consent of creditors or an order of the court, again provided that the same confirmations are made by the monitor.
The moratorium procedure aims to give the company time to progress plans for a rescue whilst having protection from its creditors. The rescue could be, for example, a refinancing, or a company voluntary arrangement (“CVA”) or a debt restructuring. It is likely that the company would have discussions with its lenders prior to entering into the moratorium, as without those discussions it would be difficult for the proposed monitor to express a view on the likelihood of rescue. In addition, given that the lender is still entitled to exercise its contractual rights during the moratorium, it is likely that a standstill with lenders extending the date that payments to the lenders which would otherwise fall due during the moratorium would need to be negotiated prior to the entry into the moratorium.
What happens if the rescue fails?
If the monitor considers that it is no longer likely that the rescue of the company as a going concern will be achieved, or that the company is unable to pay the sums it is required to pay during the moratorium period, then the monitor must terminate the moratorium, and should not consent to any further extensions of the procedure.
The directors will then need to consider what steps they should take in light of the failure of the rescue. It is likely that they would then take steps to put the company into an insolvency procedure, with the options likely to be administration or liquidation for most companies, other than those companies where the power of a floating charge holder to appoint an administrative receiver remains. Those excepted companies are set out in Section 72A of the Insolvency Act 1986, and include project companies in relation to public-private partnerships, utility projects, urban regeneration projects and financed projects with step in rights, where as a result the right to appoint an administrative receiver remains.
If that insolvency procedure commences within 12 weeks of the end of a failed moratorium, and the company did not make payment in full of all the payments falling due in the moratorium, certain of those unpaid amounts will have super priority in the subsequent insolvency.
Payments that would otherwise have fallen due to the lender to the project (including any amounts falling due under a facility that has expired or under a revolving credit facility) would be priority moratorium debt qualifying for super priority. If the lender has used its rights to accelerate debt, “relevant accelerated debt” will not qualify as a priority pre-moratorium debt for these purposes and will not have super priority. Priority pre-moratorium debts will rank ahead for payment from floating charge assets, above the liquidation or administration expenses, including the remuneration of the subsequent officeholder who is likely to be an administrator or liquidator, and payments to preferential and secured creditors.
Realisations to secured creditors from fixed charge assets are unaffected by these provisions.
(2) The use of termination clauses in supply contracts, which allow termination “ipso facto” or by reason of the insolvency
What were the ipso facto prohibitions prior to the Act?
Prior to the Act coming into force, the Insolvency Act 1986 provided that suppliers of gas, electricity, water and IT systems could be required to continue to supply to a company in an insolvency procedure and were not entitled to terminate supply agreement by reason of, or “ipso facto” the insolvency procedure. They were also not entitled to force a company that had gone into insolvency to pay arrears as a condition of further supply. All other types of supplier were able to terminate the supply contracts by reason of the insolvency, or to demand that arrears be paid before making further supplies. This was detrimental to the rescue culture if rescue of the company relied on the continuation of supplies. Other jurisdictions such as the US, Canada and Australia have implemented restrictions on the exercise of ipso facto clauses in relation to companies in an insolvency or restructuring procedure and a prohibition on the ability of suppliers to demand “ransom payments”.
How does the Act affect contracts of supply?
The Act significantly extends the prohibition on the use of ipso facto clauses in supply contracts and the restrictions on the ability of a supplier to terminate because of the entry of the counterparty into an insolvency or restructuring procedure, to all contracts for the supply of goods and services unless excluded by the Act. This will have significant ramifications in the energy and infrastructure sector as the supply chains can be complex, particularly when parties are reliant on key supply contracts for their continued operations, as we have seen in the Carillion insolvency. It does so in three ways:
- First, a provision in a contract for the supply of goods or services under which (a) the contract or the supply is to terminate, or for any other thing to take place, because the company goes into an insolvency procedure or (b) the supplier is to be entitled to terminate the contract or supply, or do any other thing, because the company goes into an insolvency procedure, ceases to have effect when the company goes into a moratorium, administration, administrative receivership, company voluntary arrangement, liquidation or has proposed a restructuring plan.
- Second, where under a provision in a contract for the supply of goods or services a supplier is entitled to terminate the contract or supply because of an event which pre-dates the buyer’s insolvency and that entitlement arises before the buyer’s insolvency, that entitlement cannot be exercised once the buyer goes into insolvency.
- Third, a supplier may not make it a condition of any supply of goods or services after the time the buyer goes into insolvency, or do anything which has such effect, that any arrears are to be paid.
The restrictions in (1) and (2) above can be overcome if the insolvency office-holder or the buyer (depending on which particular type of insolvency procedure is involved) gives consent or if the supplier can satisfy the court that forcing it to continue to supply would cause “hardship”. This term is not defined and its meaning will be developed on a case by case basis.
In practice, if the insolvent buyer does not want the ongoing supply then the company or the insolvency office-holder are likely to agree that the contract may be terminated. The supplier should communicate with the office-holder or buyer immediately upon hearing that it is in a relevant insolvency procedure to ascertain if the supply is still wanted. The company or office-holder is likely to be advised to communicate speedily with the supplier to confirm the position so as to not become liable for payment in respect of any ongoing supplies.
Which suppliers and contracts are excluded from the ipso facto restrictions?
The ipso facto provisions do not apply if:
- The supplier is a “small supplier” (although this exclusion falls away on September, 30 2020).
- Either party is a bank, insurer or payment institution.
- The contract is a “financial contract”, which includes “commodities contracts” (see further below) and swap agreements.
- The contract forms part of a PPP project.
A “commodities contract” is defined as including “a contract for the purchase, sale or loan of a commodity or group or index of commodities for future delivery”. Neither the Act itself nor the Explanatory Notes to the Act provide clear guidance as to what exactly will constitute a “commodity”, although the Act positively identifies EU emission allowances and UK renewable energy guarantees of origin as falling within the definition.
The Government is aware of this issue, and we therefore expect further guidance to be forthcoming. It is not currently clear if electricity or gas (as would be the supply under a power purchase agreement or a gas supply agreement) will be considered a “commodity” for the purposes of this exemption. We can however take some direction from conventional dictionary definitions of “commodity” which focus on raw materials and soft commodities. Other legislation, for example the Market Abuse Regulation (Regulation 596/2014) (MAR), also includes energy within the definition of commodities. The MAR’s definition of “commodity” states that “ ‘commodity’ means any goods of a fungible nature that are capable of being delivered, including metals and their ores and alloys, agricultural products and energy such as electricity”.
Payment for ongoing supplies
If the ipso facto prohibitions apply, then the provisions of the Act will require the supply under the supply contract to continue unless the buyer indicates that it no longer wants the supply and agrees that the contract can be terminated. Whilst the supplier cannot insist on the payment of arrears as a condition of ongoing supply, the restriction on the right to terminate does not affect the obligation on the buyer to pay for the supply from the date of commencement of the insolvency procedure, or prevent termination for non-payment in respect of supplies made after that time.
It is likely that, as a result of the Act, suppliers will include a wider range of triggers for termination upon signs of financial distress (for example, a ratings downgrade or a failure to meet creditworthiness tests set out in the contract) and will become more likely to act earlier in response to termination events since if they wait and the buyer goes into an insolvency procedure those rights may no longer be relied upon.
We would expect that in the vast majority of cases, the question of ongoing supply will be amicably resolved between the insolvency office-holder and the supplier. However, where ongoing supply is critical to the buyer’s business and there is a large debt outstanding to the supplier, disputes could arise. These are likely to be more complex where the supply has a cross-border element (for example, the contract is not governed by English law or the supplier is not subject to the jurisdiction of the English court) or where the supplier can show that the continuation of supply without being paid in respect of its arrears, will cause it severe difficulties.
(3) The New Restructuring Plan
The Act provides that a company in financial difficulties may propose a restructuring plan (the Plan) to its creditors and shareholders. The procedure is similar to the existing process for the approval of a Scheme of Arrangement under Part 26 of the Companies Act 2006. The first step is for the company or its creditors to make an application to court for the approval of the Plan.
If any class of creditors or members approve the Plan, the court can then consider whether or not to sanction the Plan. The Plan can allow cross class cram down and cross class cram up of creditors, if creditors representing 75 percent in value of one of the classes of creditors approve the Plan and it can then be referred to the court for sanction. The court can sanction the Plan and bind dissenting classes of creditors or members provided that:
- The dissenting classes are no worse off than they would be in the “relevant alternative”: usually liquidation; and
- The one class voting in favour of the Plan would receive a payment or have a genuine “economic interest” in the company in the event of the “relevant alternative”.
This procedure therefore could have an impact in relation to a project if one of the parties proposes a restructuring plan which affects the rights of any creditor. The creditor would then be asked to vote on the approval of the Plan. Note also that the ipso facto prohibitions would come into effect once the court convened the meetings of creditors and members.
Potential implications of the Act on projects and project finance arrangements
Implications for services contracts
If a contractor, under a services contract (such as a facilities management contract), enters into the new moratorium, a key question for the project company is whether the contractor will be able to continue to provide services and if not, how this impacts the project company’s ability to enforce its security granted by the contractor and to replace the contractor. The realisations from the security provided under the contract would ordinarily have been used to set off against the cost of contracting with a replacement contractor.
Where the security is provided by a third party, such as a letter of credit or bond from a financial institution or a parent company guarantee, the Act will not prevent enforcement of the third party security. Parent company guarantees will also be unaffected by the moratorium. However, if the contractor is in difficulties, the credit of the wider group may also be affected, so in practice the value of the security from other group members could be reduced.
Implications for construction contracts
The ipso facto provisions of the Act concerning the supply of goods and services clearly affect the construction industry and engineering sectors. They restrict the rights suppliers have against their clients; in the case of the main contractor, its employer, and in the case of a sub-contractor, the main contractor. These provisions only apply to termination clauses in "upstream" contracts. They do not apply to any rights the employer or a contractor has as against its contractors/ sub-contractors; if a contractor/sub-contractor becomes insolvent, its employer will be able to terminate if provided for in the contract between them. However, it is important to check whether an employer might be providing any ancillary supplies to facilitate the overall carrying out and completion of the works: if it is, the contract may be caught by the ipso facto restrictions Act.
Collateral warranties and construction direct agreements
In UK projects, it is common for employers to require collateral warranty agreements/ direct agreements from the key sub-contractors involved in the delivery of the works. These agreements typically give the employer the right to step in and require the sub-contractor to continue with its sub-contract works in the event that the main contractor becomes insolvent.
The ipso facto prohibitions in the Act extend beyond the right to terminate "…to do any other thing…”. Arguably, this would prevent a sub-contractor from giving notice to the employer under its collateral warranty or direct agreement in favour of the employer in the context of an insolvency of an intermediate contractor. The wording of the Act, however, does not prevent the employer from electing to step in under the warranty or direct agreement, if it has the option to do so.
The existence of the moratorium which exists in certain restructuring or insolvency procedures can prevent enforcement of contractual rights, but it is unlikely to prevent the counterparty exercising other contractual rights arising under the contract, for example the right to suspend works for non-payment. For this purpose, the key issue will be to ascertain whether the exercise of that particular contractual right can be classed as “enforcement” in the moratorium.
It is also necessary to consider whether the right to suspend is caught under the ipso facto prohibitions. The wording in the Act "or do any other thing" has been drafted widely to catch any attempt to suspend performance or attach further conditions to any continued supply. This wording could, in principle, include the supplier’s right to suspend the works/ its supply for non-payment. The Act makes clear that the restrictions apply to contractual provisions. In UK contracts where the Housing Grants, Construction and Regeneration Act 1996 (the Construction Act) applies, as the supplier has a statutory right to suspend for non-payment (s112 Construction Act), the new restriction does not affect the supplier’s rights under s112 (furthermore, the s112 right to suspend only relates to non-payment and not insolvency). If the contract also provides for the supplier to have a right to suspend works/ its supply which is triggered by its client’s insolvency, then such a provision will now be ineffective under the Act.
In contracts not caught by the Construction Act, it is necessary to consider whether the right to suspend is caught under the ipso facto prohibitions: suspension could be caught within the ipso facto prohibitions if the right to suspend arose before the insolvency event but was not exercised, and it could not then be exercised then during the insolvency period.
Can companies use the new moratorium to assist in a restructuring of a project?
In the context of a project finance transaction, the project company may be able to apply for the new moratorium provided it does not fall within the PPP exemption mentioned above or the or capital markets arrangements if it for example has issued bonds of over £10 million.
If the project company is able to go into a moratorium, it is unlikely to do so without consultation with its lenders. In order to go into the moratorium, the proposed monitor has to confirm that he or she considers that it is likely that the moratorium will result in the rescue of the company as a going concern. The monitor is unlikely to be able to form that view without understanding the position of the lenders in relation to the proposed rescue plan. Indeed, if the lenders have the right to accelerate the amounts under the lending facility, the company is likely to seek to negotiate a standstill and contractual variation of the documents so that payments will not fall due in the proposed moratorium period. The lenders and the project company may consider that the moratorium is useful to the progression of rescue and reconstruction negotiations between them, which may be being derailed by an external supplier or landlord threatening court proceedings or a winding up petition against the project company.
During the new moratorium procedure, as indicated above, liabilities falling due under a contract or instrument involving financial services do not have a payment holiday in the moratorium and continue to be payable. As a result, amounts falling due in the period in relation to the project finance debt would remain payable during the moratorium period, as would any other amount that fell due to lenders in the moratorium period. As indicated above the lender would also be able to accelerate their loan.
The project company when in the moratorium would be able to benefit from the extensions to the ipso facto prohibitions referred to above, which could assist in the rescue of the project company as a going concern and the completion of the project.
Can companies use the ipso facto restrictions to assist the restructuring of the project?
The ipso facto provisions in the Act may be beneficial for a project company subject to a restructuring or insolvency procedure, as it will not be held to ransom by suppliers seeking to renegotiate terms on the occurrence of an insolvency related event. The project company will however need to consider whether continuing the supply agreement is essential to the survival of the business in order to avoid increasing unnecessary costs, and, in the context of a project finance transaction, the lenders may wish to give their views on this issue.
What is the impact of the ipso facto restrictions on funder direct agreements?
In project finance transactions, lenders often enter into direct agreements with key contract counterparties. Under the terms of a standard direct agreement the counterparty will:
- Agree to give notice to the Security Agent before taking enforcement action against the project company.
- Agree not to take enforcement action for an agreed period after the giving of notice.
- Set out the terms upon which an appointed representative may step-in to the contract and upon which the counterparty will continue to perform under the contract for an interim period.
- Set out the terms on which the counterparty shall novate the project contract to a substitute.
Where the ipso facto prohibitions apply, the effect of the Act is likely to be that any clause in a contract (which is the subject of the direct agreement) which would allow a contractor to terminate the contract with the project company in the relevant circumstances is no longer exercisable. In that regard, the Act fulfils one of the main aims of the direct agreement. However, because the scope of a direct agreement typically is wider, providing a framework for involving the lenders in discussions with key contract counterparties, we expect that market practice will be to continue to require direct agreements in project finance transactions.
The new Act is a giant of a statute. We have produced a four-part webinar series on the Act which can be viewed here. Please get in touch with your usual Norton Rose Fulbright contact or any of the partners listed below to discuss any questions and issues.