In May 2016 the Insolvency Service issued a consultation on the corporate insolvency framework in the UK (for discussion see Part I and Part 2 of an earlier OBLB blog by this author). This was prompted in part by a desire to boost the UK’s position in the World Bank’s annual Doing Business Report, and a number of high profile corporate collapses in the intervening period have kept this issue on the political agenda. The Government has now taken account of the responses to that consultation paper and on 26 August 2018 published proposals to reform the UK debt restructuring regime. Legislation will be introduced “as soon as parliamentary time permits” (at para 5.4). The proposals are ground-breaking and will introduce an innovative and potentially powerful new mechanism into the UK restructuring toolkit, the restructuring plan. There are a number of questions that remain however, many of which will not be answered until the full legislative details are published.
This blog post will focus on just two aspects of the Government’s proposals: the introduction of a restructuring moratorium and the creation of a restructuring plan. There were various proposals consulted upon, such as the introduction of measures designed to facilitate rescue finance, which have (rightly) been dropped, as a result of responses to the consultation. Other proposals are included within the Government’s paper, such as the role of directors of holding companies involving sales of businesses in distress, but fall outside the ambit of this note.
The Government proposes the introduction of a restructuring moratorium that will be available to companies involved in restructuring (including by way of a scheme of arrangement, CVA, contractual workout or restructuring plan) as long as:
-the company is in financial distress, the test on the relevant financial state being “one of prospective insolvency, that is, based upon the requirement that a company will become insolvent if action is not taken” (para 5.29) (the 2016 Consultation Paper proposed including companies that were already insolvent but this has been rejected as a consequence of respondent’s fears that the moratorium could be mis-used by directors seeking to delay an inevitable insolvency);
-the company is capable of rescue, the test being that “rescue is more likely than not” (para 5.31); and
-the company can demonstrate that it has sufficient funds to carry on its business during the moratorium, meeting current and new obligations as they fall due.
There are also various eligibility tests that the company must meet. For example, a company will not qualify for a moratorium if it has entered into a moratorium, administration or CVA in the previous 12 months. The 2016 Consultation Paper had suggested that a winding up petition in this period should also be a bar to eligibility, but respondents expressed the concern that this might incentivise creditors to issue a petition in order to avoid being affected by a moratorium. The Government therefore proposes some flexibility on this point.
Entry into the moratorium will be triggered by filing documents at court. A moratorium supervisor appointed by the directors (a ‘monitor’) will need to file their consent and confirmation that the eligibility tests and qualifying conditions are met. Creditors will be able to apply to court to challenge the moratorium if they can demonstrate that they have suffered unfair prejudice (para 5.39). The moratorium will be for a maximum period of 28 days in the first instance (a reduction from the three month period suggested by the Insolvency Service in its Consultation paper, as a response to the comments of respondents on this issue) although extensions are possible (paras 5.51-5.56).
The 2016 Consultation Paper proposed an extension to the scope of the moratorium that exists at present in administration, to prevent customers and suppliers from terminating their contracts with the company on the grounds of insolvency. Debtor companies would be allowed to designate certain contracts as “essential” and thus incapable of being terminated on the grounds of insolvency alone. The Consultation Paper sought to address the possibility of abuse of creditors’ interests by giving creditors the right to challenge the designation in court. Respondents were sceptical that this provided creditors with sufficient protection and the Government has now dropped this idea. Instead the Government plans to legislate to prohibit the enforcement of termination clauses (ipso facto clauses) by a supplier of goods and services where the clause allows a contract to be terminated on the ground that one of the parties to the contract has entered formal insolvency. The details of this provision still need to be fleshed out. For example, the Government proposes that certain types of financial products and services will be exempted, but no further detail is provided at present.
The proposed new restructuring moratorium is potentially very valuable. Although companies can (and do) find ways around the lack of a restructuring moratorium at present, for example making use of standstill arrangements, this new mechanism may be a useful tool for companies undergoing restructuring, especially once creditors become numerous and heterogeneous. However, it may be that ithe comparatively short length of the moratorium and the need for a corporate rescue to be “more likely than not” will limit its value to companies. The Government appears to be alert to the need to ensure that creditor interests are protected during a restructuring moratorium and significant safeguards are included, often building on the established protections available in the existing moratoria that operate in the UK (available in administration and for small company CVAs). There remain some issues of concern and doubt, however, for example regarding the operation of the ban on ipso facto clauses, which can only be finally assessed once the full legislative details are published.The proposed new restructuring plan will exist alongside existing restructuring procedures. Although the restructuring plan is effectively an enhanced scheme of arrangement, the proposals recognise the value of schemes of arrangement internationally and thus leave schemes in place and unamended, so that they will continue to be available for the restructuring of companies both inside and outside the UK.
The proposals envisage a restructuring plan which will bind all creditors, including secured creditors, and will enable a cross class cramdown, as long as certain conditions are met. The restructuring plan will be available to both solvent and insolvent companies, ie there are no financial conditions in place in order to qualify for a plan. It is also envisaged that there will be no jurisdictional requirement, in line with existing schemes of arrangement, ie the restructuring plan will be accessible to companies that do not have their centre of main interests in the UK.
Of course, a cramdown of this kind needs to include protection for creditors. The Government envisages very similar protections for creditors to those that exist in a scheme of arrangement. The creditors will be divided into classes grouped by similar rights or treatment, to be decided by the company and approved by the court. The approval requirement is 75% by value voting in favour of the plan. This is a change from the approval test in a scheme of arrangement which has two elements: in addition to 75% by value voting in favour, there must also be a majority in number of creditors of each class who approve the restructuring. The majority in number test has been heavily criticised, including by this author, and the Government removal of this aspect of the approval requirement is therefore to be welcomed. However, in order to protect minority creditor interests the Government proposes introducing a connected party subtest which will require that “more than half of the total value of unconnected creditors vote in support” (para 5.155). Once the creditors have voted on the plan a second court hearing will be required to confirm the plan.
In order to ensure the protection of dissenting creditors in a cross class cramdown, the Government proposes that at least one class of impaired creditors will need to vote in favour of the scheme and the absolute priority rule must be followed, ie a class of creditors must be paid in full before any class of creditors junior to that class may receive or retain any property in satisfaction of their claims, unless the more senior class consents to any departure from this principle. The absolute priority rule is a feature of US Chapter 11 but has often been criticised as being too inflexible and a potential barrier to a debtor’s successful restructuring. The Government’s proposals seek to deal with this danger by allowing the court to confirm a restructuring plan even if it does not comply with the absolute priority rule where that non-compliance is (i) necessary to achieve the aims of the restructuring and (ii) just and equitable in the circumstances (para 5.164).
In order for the court to assess whether the absolute priority rule has been met, the Government proposes the use of a valuation based on the use of the “next best alternative for creditors”. The Government’s attempt to inject some flexibility into this issue is to be welcomed. The minimum valuation test suggested in the Consultation Paper was a liquidation valuation, but this has been criticised as being too limited. It may well be the case that administration or some other form of rescue, rather than liquidation, is the most likely outcome were a plan to be rejected, in which case a higher going concern valuation will be more appropriate. It is helpful that the Government has recognised that applying a liquidation valuation in all instances is too simplistic. However, this “next best alternative” test seems likely to open up the possibility of litigation in many cases. Arguments about valuation have played a relatively small role in restructuring cases in UK schemes cases to date, but the proposed restructuring plan will place a significant burden on English judges to deal with this issue.
It seems likely that these reform proposals are driven in part by a need to keep up with changes elsewhere in the world, including those proposed by the European Commission in its draft Restructuring Directive. In light of Brexit it is important that the UK does not fall behind in the area of restructuring. These proposals allow the English scheme of arrangement to remain intact while offering UK companies (and potentially companies elsewhere in the world) the option of the new restructuring plan plus restructuring moratorium. Once implemented, these can help to ensure that the UK remains competitive in the global market. These proposals bring challenges too, however. The restructuring plan will provide the English courts with a more difficult role, particularly in relation to valuation, although applying the absolute priority rule and the ipso facto provisions will also be challenging as UK courts have no experience with these concepts. It also remains unclear whether the detailed legislative provisions will strike an appropriate balance between facilitating rescue and protecting creditors.
Jennifer Payne is Professor of Corporate Finance Law and a fellow and tutor at Merton College, Oxford.