Restructuring Plan

The Bill includes a new restructuring plan modelled on the scheme of arrangement. It enables companies in distress to propose a compromise with creditors and/or members, or any class of them.

• Scope. The procedural aspects are very similar to a scheme i.e. there will be an initial court hearing to examine class composition, creditor meeting(s) to vote on the proposals and a subsequent court hearing to sanction the plan. The plan may be proposed by the company, a creditor or, if in insolvency proceedings, the administrator or liquidator and, unlike a CVA, will bind unsecured as well as secured creditors. The company will need to provide all classes with an explanatory statement setting out the effect of the plan as well as the material interests of the company’s directors and their impact on the plan.
• Financial Services Providers. The restructuring plan is available to financial services providers (such as electronic money institutions and authorised payment providers) subject to a number of conditions including that the appropriate regulator can be heard by the court. The Secretary of State also has the power to prevent regulated financial service providers from using the plan.
• A ‘Super Scheme’. Despite its similarities with schemes of arrangement, there are some notable differences. For instance, there is no insolvency pre-requisite for a company to propose a scheme which can be used for “solvent” companies (although typically insolvency is the comparator when assessing the fairness of the scheme). However to avail itself of the restructuring plan, the company must be in or must be likely to encounter financial difficulties affecting its ability to carry on business as a going concern. In addition, a class approves the plan if 75% of creditors in value consent – there is no need for a majority of creditors in number in the class to vote in favour as well (the so-called ‘numerosity test’ in schemes).
• Cross-class cram downs. Crucially, the plan will enable cross-class cram downs i.e the proposals may be sanctioned by the court notwithstanding that certain classes may have voted against it, subject to certain safeguards for minority interests. These are that (i) at least one in-the-money class consented and (ii) the dissenting class(es) would not be worse off than in the event of the “relevant alternative” (often referred to as the ‘absolute priority rule’). The effect of this is that a compromise can be imposed on “out of the money” creditors who might have formed a hold-out class in a scheme. It will also facilitate a debt for equity swap, something that schemes cannot achieve without requisite shareholder consent. The “relevant alternative” is whatever the court considers most likely to occur in relation to the company if the compromise were not sanctioned. This would seem to be broader than an “insolvency comparator” and could open up the possibility for challenge by creditors who have differing views on what the counterfactual scenario might be in a particular case, for example the possibility of an alternative deal which might provide more favourable treatment.
• Sanctioning the plan. Interestingly, the Government had previously proposed that the court ought to be able to sanction a restructuring plan even if the absolute priority rule is not applied, namely in circumstances where it is (i) necessary to achieve the aims of the restructuring and (ii) fair and equitable to do so. Ostensibly, it was felt that this level of flexibility would have introduced an unnecessary degree of uncertainty into the process.
• Impact. The English scheme of arrangement has been a highly effective tool in facilitating complex cross-border restructurings but has its critics. The restructuring plan, in conjunction with the availability of the moratorium, offers a further degree of flexibility to the UK restructuring regime and may be regarded as closing a perceived gap with its global competitors, particularly across the Atlantic.

Restriction on termination of contracts

The Bill introduces a prohibition on suppliers terminating the supply of goods and services on a counterparty’s insolvency. The prohibition will essentially render invalid any term of a contract for the supply of goods or services, which would allow the supplier to terminate or vary the contract upon a company becoming subject to insolvency proceedings, including the new restructuring plan and moratorium (so called ‘ipso facto’ clauses).

• Scope. The Bill adds to the existing protections to “essential supplies” i.e. the supply of gas, electricity, IT, etc. when a company enters administration or a voluntary arrangement, to include the general supply of goods and services to a company in insolvency proceedings subject to a number exceptions.
• Purpose. The reforms mean that affected suppliers must continue to fulfil their commitments under a contract with their insolvent counterparty. The reforms are intended to help businesses trade through any restructuring process and provide stability to their operations. The reforms also apply to any automatic change or right to make a change because of a counterparty becoming subject to insolvency proceedings. It also prevents a supplier making the payment of outstanding invoices a condition to continued supply i.e. so called ransom payments.
• Excluded contracts and suppliers. The prohibition of ‘ipso facto’ clauses will not apply to suppliers carrying out regulated activities (including banks and insurers) or those which are investment firms, payment institutions, investment exchanges etc. or to overseas entities. The reforms will also not affect the operation of financial collateral arrangements and set-off or netting arrangements, nor will they apply to certain derivatives, capital market arrangements and “financial contracts” including lending, financial leasing and guarantees. These exemptions provide welcome assurances to counterparties to such arrangements that the effective functioning of these types of contracts will not be undermined upon insolvency.
• Termination options. Suppliers will still be able to terminate supply contracts for reasons other than those relating to the opening of insolvency proceedings as set out in the contract e.g. non-payment as well as (where the company is in insolvency proceedings) if the officeholder consents or, in any other case, with the company’s consent. As a last resort, a supplier may also apply to court to seek permission to terminate the contract if the supplier can prove that the continuation of the contract would cause “hardship”. This mirrors the provision that applies to essential supplies but given this high bar along with the time and costs of making an application it is likely that suppliers will only use this avenue where the continuation of the supply causes it financial difficulties.
• Impact. The reforms are likely to spur suppliers to conduct a thorough review of their contracts to ensure that they can terminate upon early signs of distress and for reasons other than insolvency. We anticipate that suppliers will look to find more creative ways to terminate their contracts prior to their counterparty entering insolvency proceedings.

Temporary suspension of liability for wrongful trading

In order to reduce the pressure on directors during the Covid-19 emergency, the Government has decided to temporarily suspend the wrongful trading regime.

• Scope. In determining a director’s liability for wrongful trading, a director will be assumed by the court to not be responsible for worsening the financial position of the company or its creditors during the ‘relevant period’ i.e. any impairment of the company’s position during the relevant period is effectively disregarded. The relevant period runs from 1 March 2020 to 30 June 2020 (or one month after the act comes into force, whichever is later).
• Exclusions. Directors will still be required to comply with their general duties – for example the duty to act in the interest of creditors when the company is in the zone of insolvency – and other company and insolvency law provisions, such as those relating to fraudulent trading will still apply.
• Excluded financial services providers. The suspension will not apply to directors of most financial institutions such as building societies, credit unions and insurance companies.

Temporary restrictions on presentation of winding up petitions

In addition to the temporary relaxation of wrongful trading liability, the Government is placing temporary restrictions on the ability of creditors to present winding up petitions against struggling companies.

• Statutory Demands. A petition for the winding up of a UK registered company on the ground that the company has failed to satisfy a statutory demand cannot be presented on or after 27 April 2020 where the demand was served between 1 March and 30 June 2020 (or one month after the act comes into force, whichever is later). A creditor will not be able to present a winding up petition even following a court judgment unless the creditor has reasonable grounds for believing that: (a) coronavirus has not had a financial effect on the company, or (b) the facts by reference to which the relevant ground applies would have arisen even if coronavirus had not had a financial effect on the company.
• Inability to pay debts. Similarly, the more general ground of insolvency that a company is unable to pay its debts as they fall due may not be used to present a petition during the four month period mentioned above unless the creditor has reasonable grounds for believing that: (a) coronavirus has not had a financial effect on the company, or (b) the relevant ground would apply even if coronavirus had not had a financial effect on the company.
• Proof that assets are less than liabilities. Equally, a petition may not be presented during the same four month period on the ground that it can be proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities, unless the creditor has reasonable grounds for believing (a) and (b) above.
• Impact. The new qualifications mean that there will be a petition approval process through the courts, which will likely cause delays and be costly. Assuming the four month period is not extended, it is expected that creditors will be keeping to hand statutory demands ready for service from 1 July 2020 (or one month after the act comes into effect, whichever is later) which, absent further intervention by the Government, could open the floodgates for winding up petitions being presented in late July 2020 with the backlog of unsatisfied statutory demands.

The Bill will now be debated by each House of Parliament. Given the urgency of the situation, we expect the Bill to be approved and receive Royal Assent in short order. If you have any questions, please feel free to get in touch with the Restructuring & Insolvency team at Reed Smith.

Client Alert 2020-337