INSOLVENCY LAW REFORMS

April 2020

On Friday last week, the Government announced new measures designed to protect those who choose to continue trading through the Covid-19 crisis.  We examine the upcoming changes.

The primary changes announced by the Government are:

  1. The introduction of a “safe harbour” for directors.   Directors who cause a company to continue to trade while it faces liquidity problems will not be in breach of their directors’ duties where the liquidity problems are caused by Covid-19.
  2. Enabling companies to place debts into “hibernation” until normal trading resumes.
  3. A raft of measures to get around the practical inability of signing and sending documents while the lockdown is in place.  Importantly, the commencement of the insolvency practitioner licensing legislation will also be deferred for up to 12 months.
  4. The bringing forward of insolvency-related reforms under the voidable transactions regime to reduce the period of vulnerability from two years to six months where the debtor company and the creditor are unrelated parties.

Legislation is yet to be introduced, so the exact details remain unclear.  However, the Government has confirmed that the director “safe harbour” measures will apply retrospectively.  It would appear to us that:

 

Director duties

Only some actions by directors will qualify for the “safe harbour”.  Directors will, most notably, be relieved from breaches of the following Companies Act duties, but only where the relevant company is facing, or is within the next six months likely to face liquidity problems caused by Covid-19:

(a)   Section 135, which prohibits a director from causing, allowing or agreeing to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors.

(b)   Section 136, which prohibits the incurring of an obligation unless the director believes on reasonable grounds that the company will be able to perform the obligation when it is required to do so.

In addition, the directors must be able to demonstrate that the company was cashflow solvent (i.e. able to pay its debts as they fall due) on 31 December 2019, and must have a good faith expectation that the company will return to cashflow solvency within 18 months.

On the other hand, the Government has signalled that breaches of the duty to act in good faith (for instances by directors who dishonestly incur debts) will not qualify for protection.  In other words, it appears that if a director cannot show that he/she has breached a duty because of Covid-19 related liquidity issues, they will remain liable in the usual way.

 

Debt hibernation

A company will be able to enter into a Business Debt Hibernation (BDH) to place its existing debts into hibernation where 50% of the company’s creditors (by value and by number) agree.  A company proposing a BDH arrangement will be subject to an initial one month moratorium while creditors consider the proposal, with a further six month moratorium if the proposal is actioned.

BDH will be available to entities other than companies, such as trusts and incorporated societies, but not to banks, insurers, non-bank deposit takers, or to individuals and sole traders (who will instead be subject to the Insolvency Act 2006 – apparently, at this stage, in an unaltered form).

This option provides these entities with an alternative to the Government’s Business Finance Guarantee Scheme where loans of up to $500,000 for up to three years are available.  A BDH will presumably provide a better outcome for a company as long as its creditors do not insist on the company paying interest or penalties on the underlying debts.

The Government has suggested that the BDH scheme will provide a “simple and flexible” option for businesses, with the intention that a scheme can be enacted without the need for legal advice.   However, the option of a scheme versus alternative approaches will, in many cases, raise difficult issues, such as:

  • Business Debt Hibernation would be binding on all creditors (other than the entity’s employees, who will presumably, therefore, be unable to vote on the proposal) and would be subject to any conditions agreed with creditors.  Presumably conditions could include imposing potentially complex interest and/or penalties on the company, which will require close analysis as to whether a BDH is the best alternative.
  • It appears that a BDH could enable some creditors to be paid ahead of others. The Government has stated that payments or dispositions of property made by the company while in BDH to new third party creditors (but not related parties) would be exempt from the voidable transactions regime.  A liquidator would not later be able to unwind these transactions where the transaction was entered into in good faith by both parties, on arm’s length terms and without the intent to deprive the existing creditors of the company.   A close analysis of the circumstances will be necessary to ensure these good faith criteria are met.
  • Who qualifies as a creditor? If banks are included, they will often control the vote by value, and if the bank is not willing to support a BDS, the proposal will automatically fail.  Conversely, if the bank does support a BDS and controls the value vote, the company will really only need to get a majority of creditors by number on side, which potentially provides an unfair result to those creditors voting against.
  • What opportunity will there be for creditors to “meet” to discuss and negotiate the BDH and ask questions of management before voting?
  • The Government has stated that the full range of existing options will continue to apply, including trading on, entering voluntary administration and appointing a receiver or liquidator. Professional strategic accountancy advice will therefore remain of key importance to directors considering their options, particularly given the proposed shortening of the voidable transactions regime.

It will obviously be of great comfort to businesses that these measures are available, and we think that, overall, they will provide much greater support and opportunity to businesses navigating the Covid-19 crisis.  However, the devil will, as always, be in the detail, and caution and careful analysis will be crucial to avoid pitfalls.

If you have any questions, please get in touch with Jennifer Tunna, Michael Anderson, Mike Whale, or your usual contact at Lowndes.

 


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