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What are the changes to the UK corporate insolvency framework proposed in the recent consultation launched by the Insolvency Service? What might the consequences of the new cram down procedure and the rescue finance proposal be?
Proposals to bolster the insolvency regime
The government is consulting on four proposals designed to improve the existing corporate insolvency regime. The intention is to enable more corporate rescues of viable businesses and ensure the insolvency regime delivers the best outcomes. One of the proposals is to create a new moratorium which will provide companies with an opportunity to consider the best approach for rescuing the business while free from enforcement and legal action by creditors.
The government is consulting on four proposals which would significantly change the options available to a company in financial distress. The proposals are:
The consultation proposes a new automatic and standalone moratorium that would be available to all businesses (except for insurance companies, banks and other companies involved in specific financial market transactions) lasting for up to three months, with the possibility of an extension. The rationale behind the standalone moratorium is that it would provide debtors with time to negotiate a restructuring without the threat of individual creditors taking precipitous individual action. The key features are:
In addition, a supervisor is appointed at the commencement of the moratorium. The supervisor must be satisfied that the company is eligible for the moratorium and ensure that the company continues to meet the qualifying conditions throughout the duration of the moratorium. The supervisor, who could be an insolvency practitioner, solicitor or accountant, would be prohibited from taking any subsequent appointment in a formal insolvency process.
The proposal for a three month moratorium will give the company a strong right against creditors who will find their position frozen for three months (and potentially longer). Is this tipping the balance too far in favour of the debtor ignoring the reality that it is the creditors who commonly have the economic interest in the company at the time of a restructuring? For some companies the moratorium will merely be a delay of the inevitable end of the company and with no notice to creditors required before a company enters a moratorium, it may become a source of frustration to, for example, secured creditors who are seeking to take control of a company to protect their position.
The three month period is considerably longer than the 21 days (extendable to 42 days) proposed by the industry body, R3. The view of Andrew Tate, president of R3, is that 21 days:
should be long enough for a company to put in place a rescue plan and for it to bring creditors on board with what it is trying to do. A longer moratorium increases the risk of harm to creditors and could allow companies in the moratorium to ‘drift’ rather than sort their problems out.
The implementation of the three month moratorium proposal may see a rise in the number of court applications requesting permission to bring proceedings against a debtor during this time. This is particularly so given that a creditor will only have the first 28 days of the three month period to bring proceedings. In such applications, it will be interesting to see whether the balancing exercise and criteria currently considered by the court in an application to lift the administration moratorium will be applied. It will also be interesting to see how creditors react to the new moratorium regime and seek to protect their position in different ways, for example, asking for more personal guarantees or attempting to introduce notice periods in loan documentation before any application may be made for a moratorium.
The aim of this proposal is to make it easier for companies to maintain contracts essential to the continuation of the particular business (in addition to the existing continued supply provisions for IT and utilities). By filing an application at court, the company (or officeholder) would be able to designate certain supplies as essential when the company entered into a moratorium, administration, a CVA or the new restructuring plan outlined below.
The government envisages the officeholder or company would consider the following, and asks for views on this:
The consultation envisages that the supplier would have the ability to challenge the application, in which case, the court would be required to approve the application.
The government's view is that it 'does not wish to create an unnecessary legal burden by providing a definition of essential that is too stringent and would involve specifying what goods and services would constitute essential supplies'. An example given in the consultation is a printing company that needs specialised paper from a particular company to continue its operations.
It is clear that maintain of essential contracts is important if a business is to continue during the period in which it is in a procedure. It will be interesting to see how the proposed change (if implemented) will impact on a suppliers terms and conditions to ensure they have some protection in the contracts and whether such changes stand up to challenge.
The government is proposing to introduce a statutory, multi-class restructuring procedure, time-limited to 12 months, to aid company rescue. This will include the use of a cram down mechanism and the ability to bind secured creditors into a restructuring plan. The key elements of the proposed procedure are:
The proposal is one of the less well defined areas of the proposal but it does represents a potentially wide power to end the power of hold out creditors. However, the ability to cram down secured creditors and leave out of the money creditors behind is already available by using a scheme of arrangement and pre-pack administration—albeit, the costs of such procedures may be prohibitive to all but the larger business. Will the new proposal keep costs down to open up the ability to cram down and bind secured creditors to a wide range of businesses?
The UK lacks a broad and long-established market in specialist rescue finance and the consultation states that the government is keen to encourage greater access to finance for distressed companies seeking new funding. Their view is that greater availability of rescue finance should contribute to a reduction in the number of companies with viable futures failing.
This part of the consultation is fairly open in that it seeks views on how the objective of encouraging rescue can be achieved. It does provide some possible options being:
The latter is potentially a significant development as the existing charge would be subordinated even where consent was not given. Views are sought on what safeguards would be required to ensure protection for existing charge holders. The consultation envisages that any such approvals would have to satisfy the court that:
The proposal raises a number of questions and it will be interesting to see how secured lenders will react to it and whether the proposal will be successful this time around. Will lenders insist on being given first refusal to provide rescue finance so they are not trumped by a new lender at the 11th hour? Will lenders see this as an erosion of their ability to influence the restructuring process and protect against their exposure to an ailing borrower?
The consultation document can be found here.
The consultation closes on 6 July 2016.
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