Over the last two years, BEIS has issued a number of consultations either focussed on, or touching upon, corporate governance issues in insolvency or the broader insolvency framework. BEIS has now published its formal response to these consultations (the “Response”) and, although many of the key areas are subject to further consultation, the Response does confirm an intention to make significant changes in insolvency legislation to reinvigorate the UK’s rescue culture by utilising key concepts from Chapter 11 and similar procedures in other jurisdictions – notably, the introduction of a cross-class cram-down mechanic – the “Restructuring Plan” and a new moratorium available to pre-insolvent businesses.
Timing for implementation of the reforms is unclear, and Weil will issue updates as and when further details become available.
- Insolvency Framework
A. Restructuring Plan
- Objective: to provide a mechanic to cram-down classes of non-consenting creditors (not possible under a CVA or scheme). Importantly, the Restructuring Plan will not replace the CVA or scheme but will be an alternative or additional restructuring route.
- Mechanic: similar to a scheme (i.e. 75% by value), but instead of the scheme’s further voting threshold of ‘a majority in number’, a majority in value of unconnected creditors test (similar to the CVA rules) will apply. The company would promulgate a Restructuring Plan (as the information required to be disclosed to creditors to allow them to consider the Restructuring Plan could only be provided by the company). However, the Response does envisage creditors being able to make counter-proposals.
- Comparator: the consultation originally put forward the idea of a liquidation comparator only but, following the consultation process, this element has been revised to allow for the more flexible ‘next best test’. This new test may give rise to disputes on the often controversial question of valuation.
- Exclusions: surprisingly, the Restructuring Plan would not be available for capital markets companies to avoid “interfering with the proper functioning and integrity of those markets”. Given the prevalence of capital market structures and the fact that no such exclusion applies in relation to access to Chapter 11, this may limit the application of the process and therefore undermine the value of the reform.
- Open points: critically, what has yet to be decided is whether this process could apply to companies that do not have an English COMI but have some other nexus to the jurisdiction. The government’s ultimate decision on this point will determine whether this is a major tool in England’s cross-border restructuring framework or of more limited, domestic application.
- Objective: establish a standalone moratorium for pre-insolvent companies, i.e. not yet insolvent but will become insolvent if action is not taken. This is intended to allow companies to address their financial difficulties at the earliest opportunity without limiting creditors’ rights unduly.
- Eligibility criteria: the Company must satisfy three criteria:
- ‘pre-insolvent’ per above;
- the company is able to carry on its business, meet its current obligations as they fall due during the moratorium and new obligations that are incurred in the moratorium; and
- prospect of rescue more likely than not.The moratorium will not be available where the company has been in an insolvency process at any time in the preceding 12 months. This rule should be borne in mind in planning for a potential second / subsequent restructuring. Like the Restructuring Plan, the Response expressly excludes capital market companies from the scope of the moratorium.
- Duration: 28 days following the court application, but this period can be extended to 56 days or, with creditor consent, a longer period.
- Monitor: a ‘monitor’, an insolvency practitioner and officer of the court, will oversee moratorium. The monitor’s main function is to ensure that the eligibility criteria for a moratorium to apply are met and maintained. The monitor must sanction all non-ordinary course dispositions of the company’s assets. Notably, the monitor will be disqualified from acting as administrator or liquidator in any subsequent insolvency process, but may act as supervisor in a CVA or take a role advising in relation to a Restructuring Plan once agreed by creditors.
- Costs: costs incurred during the moratorium process will be entitled to super priority status over any costs or claims in any subsequent administration or liquidation including the expenses of such procedures.
C. Insolvency Event Termination Clauses
- Proposal: a prohibition on the enforcement of insolvency event termination clauses in contracts for the supply of goods and services and contractual licenses (also a feature of Chapter 11) when a company enters a formal insolvency proceeding, the Restructuring Plan process or a pre-insolvency moratorium.
- Safeguards for counterparties: In any subsequent administration or liquidation, counterparties will be entitled to super priority (including priority to pre-insolvency moratorium costs) for their post insolvency claims and, in cases of hardship, may seek the court’s permission to terminate a contract. This prohibition will not prevent counterparties’ from exercising other termination rights (due to non-payment, for convenience, etc.).
- Scope: material broadening of the protections compared to current ‘essential suppliers’ regime. If implemented as proposed, this should be seen as a significant value-maximising reform.
D. Rescue Financing – not adopted
- Proposal: The consultation proposed a DIP style-financing regime be implemented to give financiers of rescue loans access to collateral and improved ranking.
- Response: Respondents felt strongly that the market functions well in this regard and therefore the Response concluded that no measures need to be taken. The analysis noted in the Response is that companies with viable businesses have not typically failed to secure rescue financing, particularly given the willingness of existing lenders to extend further credit and for typical LBO structures to accommodate further debt incurrence.
2. Governance and Stewardship
At the centre of the governance proposals set out in the consultations and Response is the concern that the current governance framework, in its broadest sense, does not adequately protect stakeholders from either irresponsible or unethical decisions by management/shareholders at a time when a business is in or near financial distress.
A. Selling a Distressed Business
- Proposal: measures to be introduced to enable the disqualification of a director of a holding company if within 12 months of the sale of a large distressed subsidiary, such subsidiary enters administration/liquidation where the director did not have a reasonable belief that the sale would lead to a better outcome for creditors that an administration or liquidation. The consultation envisaged personal liability (rather than disqualification) for directors’ contravention of these rules, but respondents felt this might result in directors facing perverse incentives to place group companies into insolvency rather than risk liability that may follow a sale, which could be value destructive.
- Scope: many restructurings use administration, receivership or security enforcement as means to effect such a sale. In circumstances where the holding company itself were selling, it would be important for the directors to seek specific advice on the sale which should include analysis of the financial position of the subsidiary, investigation of the alternatives to a sale and engagement with stakeholders of the entity being sold.
B. Value Extraction Schemes
- Objective: the consultation sought to address a number of ‘value extraction schemes’, including the payment of dividends diverting value away from creditors, including pensions claims, even when a business is in or near distress (e.g. by use of interim dividends). The Response concludes that this is a matter that requires further investigation and consultation.