Covid-19 proposed changes to UK insolvency laws

The changes include a temporary suspension of wrongful trading provisions for company directors, intended to allow them to run their businesses and make difficult decisions during the pandemic without the threat of incurring personal liability by doing so. Whilst the suspension of wrongful trading is a specific measure in response to the impact of Covid-19, the government will also introduce legislation “at the earliest opportunity” to implement new restructuring procedures. These changes will build on government proposals which were consulted on and announced in 2018 and are likely to have a wider-ranging and structural impact on UK insolvency law. The proposals include an interim moratorium to protect companies in difficulty and the creation of a new restructuring plan procedure.

The government are yet to elaborate on when the changes will be introduced, but it is possible that the suspension of wrongful trading will be fast-tracked when parliament reconvenes on 21 April. While the proposals are currently short on detail, we summarise the potential changes and explore the implications for companies and directors below.

Wrongful trading

Proposed change

• A temporary suspension of wrongful trading provisions for company directors. Under s.214 of the Insolvency Act 1986 (the Act), the court may declare a company director personally liable to pay compensation if the company has gone into insolvent liquidation and, at some time before that, the director knew or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation and did not take every step to minimise the potential losses to the company’s creditors.
• The suspension will take effect retrospectively from 1 March 2020 and last for three months – the government has said that the implementing legislation will include provisions to extend the change if necessary.

Potential effects

• Potential liability for wrongful trading has been an area of uncertainty since the outbreak began, as it may cause directors to cease trading or consider filing for insolvency proceedings pre-emptively as a way to avoid potential liability. The provisions’ suspension therefore provides clarity for directors on this point at least and has been welcomed by industry bodies including the City of London Law Society Insolvency Sub-Committee (CLLS).
• There is a question as to whether the suspension of the wrongful trading provisions was required in the first place. Establishing the requisite elements of a wrongful trading claim are problematic for insolvency officeholders even under “normal” circumstances, given the need to establish what directors “ought to” have concluded and the steps they “ought to” have taken. Judges have historically been reluctant to second guess, with the benefit of hindsight, the actions of essentially honest directors operating in difficult circumstances. Given that numerous companies and their directors are facing exceptional and challenging circumstances caused by Covid-19, it is reasonable to question whether a court would ever exercise its discretion to make an order against a director of such a company even if the provisions had not been suspended, except in cases of obvious wrongdoing.
• On the basis of the government’s announcement, the provisions have been suspended for all companies, rather than those specifically affected by the outbreak. There may be some risk of companies abusing the measure by continuing to trade on, despite poor performance which is unrelated to Covid-19 and causing losses to creditors by doing so. But creditors will still have a degree of protection on the basis that directors will remain subject to fraudulent trading provisions under the Act in addition to having to comply with their fiduciary duties as directors (which require them to have regard to the interests of creditors, rather than shareholders, where a company is insolvent or approaching insolvency). These provisions may deter abuse, but also mean that even well intentioned directors should not assume the suspension of s.214 gives them a free ride.

Interim moratorium

Proposed change

• A moratorium of up to 90 days in duration that will grant companies facing Covid-19-related liquidity issues the time and “breathing space” to seek a rescue or to restructure and prevent creditors from enforcing debts during that period.
• Protection of companies’ access to supplies and the ability to accept new borrowings during the moratorium to facilitate continued trading.
• The measure will build on government plans for new restructuring procedures which were announced in August 2018 - the announcement does not clarify whether the moratorium will be available to companies that are already insolvent.

Potential effects

• Whilst the government has not provided any specific detail, the CLLS has published its proposals for mitigating the effects of Covid-19 on viable businesses, including a consideration of the moratorium. It is expected that the government’s plans for the moratorium will be heavily influenced by these proposals.
• The proposals follow the government’s announcement in 2018 that it was aiming to introduce a wide ranging moratorium as part of a package of wider reforms to UK insolvency law. However, in order to prevent companies from abusing the process, the government’s proposals set out a requirement that in order to access the moratorium the company should be capable of paying any debts which fell due during the moratorium period. A similar requirement in the current environment might severely limit the number of companies able to access the relief.
• The government has said that the measures will protect companies’ supplies to “enable them to continue trading during the moratorium”. A question is whether this suggests that the changes would include a prohibition preventing suppliers from enforcing certain contractual termination clauses (ipso facto clauses) during the moratorium. We considered the potential implications of a potential prohibition on ipso facto clauses at the time of the government’s announcement in 2018 - our analysis provides background on the initial proposal and the questions we raised will continue to apply should the government include such a prohibition as a feature of the interim moratorium.
• A particular concern for banks and other lenders is how the moratorium would be regulated to prevent abuse and how existing lenders, particularly those with first-ranking security, will be protected should companies be able to borrow additional funding during the moratorium. The CLLS suggests that the risk of abuse of process could be mitigated if the moratorium could be set aside by the court upon proof that there is no realistic prospect of creditors being paid in full after the crisis has passed. The Act’s provisions on transaction avoidance (preferences, transactions at undervalue and transactions defrauding creditors) would continue to apply, and the look-back periods for such breaches (six months or 2 years) could also be extended to include the moratorium period, preserving an avenue of enforcement for creditors. The CLLS also recommends the introduction of an optional declaration that the company’s difficulties are caused by the Covid-19 pandemic. The declaration could be filed electronically by a director of a company, giving businesses breathing space in circumstances where a winding up petition is presented or threatened, which might be a way to regulate abuse of the moratorium by ineligible businesses. Without at least some of these protections being introduced there may be a risk of directors using the moratorium, together with the relief from wrongful trading referred to above, to trade on when filing for administration would result in a better outcome for creditors.
• Whilst the measure’s intent is positive, there is a question regarding whether it will be widely used. In the current circumstances, creditors (other than particularly aggressive parties or those also facing liquidity issues) may choose not to enforce their rights against companies specifically affected by Covid-19, considering both the risk of reputational damage and the possibility that recoveries from enforcement action are likely to be severely diminished whilst the economy is effectively locked-down and asset values depressed.
• Companies might also find lenders willing to renegotiate existing debt packages during the crisis in light of other government measures and guidance, such as protection for commercial tenants and forfeiture provisions under the Coronavirus Act. In relation to UK bank lenders, the PRA has issued guidance urging banks to “carefully consider their responses to potential breaches of covenants” by borrowers caused by the Covid-19 pandemic. This suggests that banks are expected to demonstrate good faith (a concept not typically implied into commercial agreements under English law) by: (i) declining to aggressively enforce against borrowers who default directly as a result of Covid-19; and (ii) advancing new finance (which may include one of the recently announced government-backed financing schemes for companies in difficulty) to otherwise viable businesses - an expectation reiterated by the Business Secretary during the government’s daily briefing on 1 April (although, anecdotally, these schemes appear to be suffering from teething problems). Overall, companies can take some comfort from measures which have already been taken, even without the benefit of a further moratorium.

The new restructuring plan

Proposed change

• The creation of a flexible “new restructuring plan” - a company rescue vehicle that includes the ability to bind classes of creditors who vote against it (also known as cross-class cram down).

Potential effect

• The government’s statement does not expand on the proposal other than to suggest it will align with the plans announced in August 2018.

There were already areas of uncertainty in respect of the government’s August 2018 plans and it is difficult to see how the government will fast-track the introduction of an entirely new rescue procedure into UK insolvency law in sufficient time for it to be used by companies affected by the outbreak in the short term. We therefore view this aspect of the proposals as the least likely to be implemented (at least for the time being).

Conclusion

While the government’s announcement sends positive signals to directors of businesses under immense pressure due to the Covid-19 outbreak, the devil will be in the detail, particularly with regard to the proposed moratorium (and restructuring plan) proposals.

The suspension of wrongful trading provisions will be simple to enshrine in law, but it remains to be seen whether it will have a material impact on promoting the survival of viable businesses during the height of the pandemic.

Due to complexity of the interim moratorium and new restructuring plan, and the risks of unintended consequences, it is likely that legislation implementing those measures will take longer to move through parliament. Timing should become clearer upon the government’s return from recess on 21 April.