Government announces potentially seismic changes to restructuring regime
Over the Bank holiday weekend, the UK government announced that it intends to introduce new legislation to implement certain measures (detailed below) as soon as parliamentary time permits.
The measures would have a potentially seismic effect on the UK's restructuring and insolvency framework - aligning (at least in theory) the UK's restructuring framework much more to the US Chapter 11 regime."
Below is what you need to know at-a-glance about the proposed reforms.
Background to the announcement
The Government issued a consultation in May 2016 on the corporate insolvency framework which followed the Conservative Party's 2015 election manifesto pledge to get the UK in the top five in the world, and number one in Europe in the World Bank's annual Doing Business Report. Following the two high profile corporate failures of Carillion and BHS the Government issued a further consultation in March 2018 on insolvency and corporate governance.
New restructuring tools
Two new restructuring tools will be introduced:
- A restructuring moratorium; and
- A restructuring plan.
What is the restructuring plan?
A new restructuring tool modelled broadly on the current scheme of arrangement (which will bring with it decades of jurisprudence and thereby introduce some element of familiarity and certainty into what is otherwise a brand new tool) but with important changes. This is the most groundbreaking of measures and would introduce a seismic change to the insolvency and restructuring toolbox. So what is it?
- The voting threshold for each class will be 75% by value to vote in favour of the plan (this part is the same as for the existing scheme).
- There will be no majority in number test (unlike a scheme) but instead, a connected party subtest will be introduced. This is loosely modelled on the test currently found for company voluntary arrangements and will require more than half of the total value of unconnected creditors to vote in support.
- Cross class cram down will be permitted (unlike in a scheme). More precisely, this means that if at least one class of impaired creditors vote in favour and the absolute priority rule is followed (i.e. dissenting class of creditors must be satisfied in full before a more junior class may receive any distribution) then the court can sanction the scheme.
- The court can also sanction the scheme if the absolute priority rule is not met where non-compliance is: (i) necessary to achieve the aims of the restructuring and (ii) just and equitable. In order for the court to assess whether the absolute priority rule has been met, the regime will adopt the use of the “next best alternative for creditors”. Often administration will be the comparator, but liquidation may sometimes be the only realistic alternative.
What is the restructuring moratorium?
A company which meets the following qualification conditions will be able to file documents at court triggering a moratorium on enforcement action. The company is:
- financially distressed but not yet insolvent;
- has a prospect of rescue; and
- can demonstrate that it has sufficient funds to carry on its business during the moratorium, meeting current and new obligations as they fall due.
The directors will appoint a "monitor" (a qualified insolvency practitioner) whose task it is to assess whether the qualification conditions are met and if at any point they cease to be met, terminate the moratorium. Creditors may apply to court to challenge the moratorium if the qualification conditions are not met or they can demonstrate that they suffer unfair prejudice. Initially the moratorium will be for 28 days - but extensions are possible (with different mechanisms, depending on their duration).
Ban on ipso facto clauses
Alongside the two new regimes, contractual termination rights that can be triggered upon a counterparty entering a formal insolvency process (including the two new ones) will be unenforceable. Certain types of financial products and services are to be exempted (but no further detail is available at the moment). Counterparties may apply to court to be permitted to terminate if they can demonstrate undue financial hardship.
Sale of businesses in distress
The government will proceed with the consultation proposal that directors of holding companies will be legally obliged to take into account whether the sale of a large subsidiary is in the best interests of the subsidiary's stakeholders - as opposed to placing the subsidiary into formal insolvency proceedings. The proposed look-back period to assess whether the subsidiary's creditors have been worse off will be 12 months. Sanctions for non-compliance will include disqualification for directors.
Value extraction schemes
By contrast, no new legislation will be introduced in relation to so-called "value extraction schemes". However, existing insolvency legislation (e.g. in relation to extortionate credit transactions and preferences) will be updated to address concerns raised in the consultation.
How does the Government’s response fit in with developments in Europe?
As we reported in November 2016, the EU published a draft directive on insolvency, restructuring and second chance. The EU's proposals also include a moratorium and a restructuring plan with cross class cram down. Since 2016 the EU juggernaut has been making slow but steady process on the consultations involved in the draft directive and it is expected that a final directive on some (if not all the initial measures) will be enacted before the next European elections in May 2019.
Neither the 2016 consultation nor this government response mentions these European developments, choosing instead to focus on the UNCITRAL Legislative Guide on Insolvency Law and the World Bank's Doing Business report. Given the timing of the UK's withdrawal from the EU, the UK would most likely not be obliged to implement any EU restructuring directive. In light of Brexit, it remains ever more important that the UK's restructuring regime does not fall behind - and the measures now announced would help to ensure that the UK stays ahead.
Is this the UK’s answer to Chapter 11?
In our November 2016 briefing on the EU's restructuring directive we asked if this was the EU's answer to Chapter 11. The current UK government's proposals certainly have some familiarity with Chapter 11 - although an important proposal that was included in the 2016 consultation and that will not be taken forward is rescue finance.
While it is the intention to introduce these measures as soon as parliamentary time permits, given the Brexit time pressures it remains to be seen when the new tools will be on the statute book. The devil is in the detail and extensive drafting will need to follow, but the announcement now raises some immediate questions such as:
- Restructuring moratorium: given the requirement to meet current obligations as and when they fall due as well as any new obligations incurred the level of protection afforded is not yet clear. Will we see companies strategically deciding when to file for the moratorium avoiding a large payment (e.g. interest on loans) on the day of filing? How will administration case law for example in relation to rent (solved by the Court of Appeal in Pillar Denton holding that rent is payable on a daily as-you-use-it basis) be transposed to the moratorium?
- Restructuring plan: the government listened to views expressed in consultation that it would be too simplistic to have only liquidation value as comparator - but the reference to the "next best alternative" is likely to open up litigation in many cases - with the courts having to take a commercial view on valuation. This could make the new regime more like the US at least as regards the volume of disputes required to be settled by the court.
- Ban on ipso facto clauses: termination rights will only be switched off if they arise because of the insolvency process (or “reasons connected with the debtor company’s financial position”); termination for other grounds will remain an option. This is undoubtedly a benefit to a distressed business but well-advised counterparties may be able to rely on a termination ground that is not directly linked to the insolvency and therefore able to terminate regardless. What will be the definition of “goods and services” to which the ban on termination will apply – an exemption for “certain types of financial products and services” will be included but the scope is unclear.
- Director accountability: how will directors of holding companies balance the existing duty to act in the best interest of that company with the new duty to also act in the interest of the subsidiary’s stakeholders? Many of these points were made by stakeholders in the consultation response but it would seem have not been taken on board. Will becoming a director in times of distress become even more complicated to navigate in the future?