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Restructuring Trends

Corporate Insolvency and Governance Bill 2020

The UK is facing its most widespread corporate challenge in a generation due to the impact of the COVID-19 pandemic on the markets and the wider economy. As a consequence many companies, even those which were on sound financial footings before the crisis, are facing solvency difficulties as their markets disappear or face significant change. Unlike the 2008 financial crisis, this crisis is touching every sector of the economy. There has never been a more appropriate time to introduce wide ranging insolvency reform. 

The proposed changes were set out in the Corporate Insolvency and Governance Bill 2020 (the Bill)  which had its first reading in parliament on 20 May 2020. Once enacted, these changes will provide companies and their directors with a number of additional options to assist them in overcoming financial challenges.  It is a Bill geared around business rescue and survival.

In summary, there are four main changes: (1) a new company driven moratorium process; (2)  a new restructuring plan, with more bite than existing schemes; (3) the extension of certain rules to assist trading in any insolvency process, and  (4) a time extension of the forbearance in wrongful trading and winding up petitions introduced shortly after the crisis started.  

These changes should greatly assist directors of eligible companies to work with creditors to restructure their balance sheets and continue as going concerns. Since balance sheet recalibration by itself is never the whole story, the Bill has also added a number of useful mechanisms to assist continued trading during these periods, such as restrictions on so called ipso facto clauses which will reduce the leverage available to  duress creditors (although it should be noted debtor-in- possession financing is not included in the Bill).

 

In this edition of Restructuring Trends we have set out some of the measures that we consider will be most relevant to directors and other stakeholders as they are looking to assess the options available to them.

The first major change likely to be seen in practice is the introduction of the standalone moratorium for a company in financial difficulty. This has been compared to the Chapter 11 process in the USA, where the debtor, acting through its board, stays in control of business operations during the process.  

The period of moratorium can last from an initial 20 business days for up to 12 months and is intended to provide the company with a stable platform from which to negotiate and deliver a plan for the company to restructure its liabilities and survive as a going concern. 

The exit from moratorium is envisaged to be via refinancing, a restructuring plan, or Company voluntary arrangements (CVAs) process. If the moratorium fails, the company will likely fall into administration or liquidation.

Current CVA’s for medium and large companies do not have an automatic stay during the preparation period. On this point, if CVA’s are habitually used to exit moratorium, we hope that the extra time to consult creditors and assess the company’s viability will help avoid the embarrassing trend which recent years has seen of CVA’s which fail shortly after they are launched. We also note that the application of the moratorium process may not be as widespread as hoped given the exclusion of companies who are party to capital market arrangements where the value of that arrangement is in excess of £10m.

To ensure the business is being managed properly during the moratorium,  the Bill has created a new role of Monitor who is appointed by the court on the company’s application and who is required to be an insolvency practitioner. The Monitor has an overriding obligation to attest that it is likely the company can restructure its affairs and survive post restructure as a going concern. This is a continuing obligation while the company is in moratorium. 

The second key change in the Bill is the introduction of a new Restructuring Plan which is closer in genesis to a Scheme of Arrangement than CVA with one key exception. Thankfully this is a Plan which is exclusive for companies in financial difficulty, unlike Schemes.   

The key element of the Plan is the introduction of a cross class cram down for those creditors and possibly (subject to interpretation) shareholders who have no economic interest in the restructuring, with the proviso that they do not get less than the most likely alternative to the plan (such as from a liquidation). 

Approval of the Restructuring Plan will require approval of 75% of creditors by value, within each class with an economic interest in the company but, unlike in a Scheme, there will be no requirement that the plan be approved by a majority in number. 

At its best, the Plan should disarm hold-out creditors who seek to derail restructuring processes of distressed companies. The Court will be the final arbiter where valuation disputes and relevant alternatives may well become the points of issue in a contested confirmation hearing with perhaps less focus on class composition. An open question at present is whether it is possible for a Restructuring Plan to compromise both shareholders and creditors at the same time for example through a debt for equity swap.

Thirdly, the Bill seeks to extend the ipso facto principle to all companies which go into an insolvency process; this should assist trading and minimise the ability of suppliers to use an insolvency to gain an advantage over other suppliers with less commercial leverage (e.g. duress creditors).

Finally, there is an extension of the current suspension of the wrongful trading regime which covers the actions of directors for the period from 1 March 2020 to 30 June 2020 and continuing restrictions on the use of winding up petitions. The latter provision will provide that creditors can not present a winding up petition unless they can prove there has been no financial effect from COVID-19 or that the grounds for the petition would have arisen irrespective of COVID-19. 

The measures which the Bill  introduces are designed to provide more companies with the opportunity to survive as going concerns. Clearly, the measures must form part of an overall operational and financial restructuring solution if success is to be assured. It will be interesting to see whether the eligibility criteria get extended as the Bill works its way through the parliamentary process as we are seeing the impact of COVID-19 affect all corporates irrespective of their size, scale or financing structure.

Moratorium

Mike Jervis and Rachael Wilkinson

The Bill introduces a standalone moratorium, which leaves the current management to run the business on a day-to-day basis.  It is a welcome addition to the toolkit of restructuring professionals. It gives struggling businesses formal breathing space to pursue a rescue plan and curtails certain creditor rights including the right to bring legal action. This is particularly vital in the current environment to ensure that businesses struggling as a direct result of COVID-19 have the opportunity to survive.

While a company seeking a moratorium must pass the standard insolvency test “is or is likely to become unable to pay its debt”, it is clear that the moratorium is not intended to delay an inevitable failure. In order to obtain a moratorium the Monitor must confirm it is likely to result in the rescue of the company as a going concern, although there is a temporary relaxation of this due to COVID-19 by the addition of  the words “or would do so if it were not for any worsening of the financial position of the company for reasons relating to coronavirus”.  In addition there are further checkpoints in the Bill where the going concern confirmation has to be reaffirmed, including extensions to the initial 20 day period, the granting of security or disposal of certain assets during the mortarium.  

Certain companies are ineligible for the moratorium in particular, those who have been subject to an insolvency procedure in the previous 12 months, including a CVA. Certain financial services businesses such as banks, insurance companies and payment institutions are also ineligible. The Bill also excludes companies subject to capital market arrangements, the definition of which is broadly drafted. This follows earlier precedents such as those in the so-called Enterprise Act, showing that government is wary of amending insolvency provisions in structured finance cases for fear of alienating investors. The flip side is that the moratorium is unlikely to be a suitable tool for achieving complex financial restructurings.

The moratorium gives companies a payment holiday for pre-moratorium debts that fall due during the moratorium period and will give companies financial breathing space to pursue a restructure, refinance or CVA with the extension of the Ipso facto principle further assisting this. Certain debts such as wages and salaries, including holiday pay and redundancy payments, are not included in the payment holiday and businesses will need to ensure that payment is made for goods and services supplied during the moratorium, including rent and amounts due under finance contracts.  The latter is of particular importance as it captures both loan interest and capital repayments due during the moratorium period.

While it is expected that most companies would seek to take full advantage of the payment holiday, the legislation provides a restriction on payments the company can voluntarily make to creditors for which there is a payment holiday. The maximum payment a company can make (per creditor), without the consent of the Monitor or the Court being the greater of £5,000 or 1% of the pre-mortarium debts.  This is an important control to ensure that individual creditors are not preferred and will be particularly relevant in group situations where one company within a larger group is subject to the moratorium.

The moratorium also presents an interesting position for holders of a floating charge, there is no requirement to obtain consent or give prior notice of a moratorium application to a floating charge holder and once in force the moratorium prevents the crystallisation of floating charges.  Indeed floating charge assets can continue to be sold in the normal course of business without any consents from the charge holder(s). While this may appear to erode the power of the secured creditor, in practice it is unlikely a restructuring will be successfully achieved without engagement with and support of the secured creditors, in particular as loan interest and capital repayments are excluded from the payment holiday. The ability to grant security during the moratorium period, with the consent of the Monitor gives an option for lenders to provide additional support, where appropriate. Understanding the cash needs of the business and engagement with lenders through the moratorium period will, therefore, be essential for both the directors and the Monitor.  In addition, as survival of the corporate entity is the objective, ensuring matters such as redundancy and tax are viewed through the lens of a going concern will be important to achieving a sustainable restructure.

The initial moratorium period is 20 days with the directors having the ability to file for a further 20-day period without reference to the creditors. We expect that it will be challenging for most businesses to achieve a successful rescue in the initial 20 day period and that an extension will be required in most cases. For more complex situations there is the option to extend the moratorium by up to one year with the consent of the creditors or the court.  In addition, there are specific provisions to extend the moratorium where a CVA is proposed.

In summary, for those companies that are eligible for the moratorium, together with the other provisions of the Bill, it will offer an opportunity to rescue the company with the aim of this leading to a better outcome for creditors than an administration or liquidation. But early engagement with key stakeholders and a clear understanding of the short term cash flow will be critical.

Please get in touch with Mike Jervis or Rachael Wilkinson for further information.

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Monitor

Russell Downs and Rob Lewis

The Monitor is the first new legislative role since the Administrator and the individual must be a licenced Insolvency Practitioner to perform the role.  

They are clearly invested in the success of the debtor and their role, put simply, is to provide an independent regular check “for the purpose of forming a view as to whether it remains likely that the moratorium will result in the rescue of the company as a going concern”.  This includes signing off specific actions taken by directors to test that those actions mean a successful outcome remains likely to occur. 

In reality, any PwC individuals working as Monitors will work very closely with management, directors, any company advisors and all creditors with a financial interest in the company, to help pull together a restructuring solution that will enable the company to continue as a going concern and also deliver a better outcome for creditors than the insolvency alternatives.

Given the Monitor will need to consent to; a) any property disposals in excess of the usual course of business, b) granting of any security, c) certain payments (e.g. payment for pre-moratorium debts in excess of £5,000 or 1% of the outstanding value claim value) and, d) any proposal to extend the period of the moratorium beyond the initial 20 business days, they will need to be kept fully informed by the directors.  Furthermore, the monitor can terminate the Moratorium at any point if they no longer consider a successful outcome likely or if they do not have enough information to be able to perform their role. 

The Insolvency Practitioners here at PwC believe this role will be a pivotal element of future restructurings for eligible companies and we will look to implement it, in the right situations, as part of our ongoing offering

Please get in touch with Russell Downs and Rob Lewis for further information.

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Restructuring plan

Ed MacNamara and Issy Gross

The new Restructuring Plan has been designed based on the existing Scheme of Arrangement process but with new provisions aimed at making it easier to be imposed on a dissenting class of creditors and/or members with no economic interest in the company. To be eligible the company must be facing, or likely to start facing, financial difficulties and to be proposing a compromise or arrangement to eliminate, reduce or prevent those financial difficulties.  The type of companies that can use this tool is much wider than that of the moratorium as the capital market restrictions do not apply here. The application can be made by the company, the creditors or, if relevant, an Administrator or Liquidator. 

This process gives the court reasonably far reaching powers to agree Restructuring Plans based on the principles below, including the compromise of debt, the transfers of property, amalgamation of companies, transfer of policies and the dissolution of companies. 

The Restructuring Plan will be sanctioned by the Court if it is a compromise or arrangement that:  a) is approved by 75% (by value) of creditors/members who have an economic interest in the company, and, b) provides that any dissenting creditors would not be any worse off than the most likely alternative scenario should the plan not be accepted (decision on whether the creditor is any worse off and what the most likely alternative is is decided by the Court). It is worthy of note that the Bill refers to “the most likely alternative scenario” and therefore careful consideration will need to be given to what that alternative might be, with liquidation not always being the appropriate alternative (as opposed to the CVA process where the comparator is always Liquidation).

The inclusion of both (a) and (b) gives the Court the ability to take a view on the proposed Plan and impose it on dissenting groups of creditors (‘cramming them down’). This ability to cram down does not just apply to financial creditors but operational creditors as well (including landlords) and could potentially be very interesting in respect of pension scheme deficits. This is a significant additional tool in the restructuring tool kit, as it can make the lives of those holding nuisance value claims or any out of the money stakeholders much more difficult in terms of aggravating a restructure.

In addition, we can envisage scenarios where it can be used in combination with administration to cleanse the company of any onerous obligations.

The major carve out to the ability to compromise debts based on the 75% voting threshold is in respect of creditors incurred during a moratorium, if the moratorium ended within 12 weeks of the proposed Restructuring Plan.  If that is the case, the moratorium creditor cannot be crammed down and instead, each must consent individually to the plan if their debt is to be compromised. There is also a carve out for cramming down aircraft related interests, which is an interesting addition given the current economic situation in the aviation industry. 

In summary, this is an exciting new tool which we hope will smooth the restructuring process and facilitate the ‘in the money’ parties coming together to create a solution in the best interest of all creditors. 

Please get in touch with Ed MacNamara and Issy Gross for further information.

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CVAs

Zelf Hussain and Jane Steer

The Bill creates a tool (the moratorium) which will help companies transition into a CVA.  There is even a specific reference for the initial moratorium period being extended to finalise a pending CVA proposal.  

In the past companies were at risk of creditor action preventing the consideration of a CVA.  This now provides management with breathing space to pull together a restructuring plan that all stakeholders can consider without the threat of being wound up. The moratorium provides up to 40 days protection, without the need for creditor approval. There are also specific provisions in the Bill where a company has proposed a CVA which can further extend the moratorium through the period of proposal and voting until the end of the challenge period giving businesses up to 4 months of protection in total.  Ultimately this should create greater opportunities to save companies as a going concern. 

CVAs are a very useful tool in the overall restructuring process and in these current times they are even more relevant and applicable.

However, in recent times CVAs have received criticism for how they have been used.  This was due to their high failure rate linked to the fact that they were rarely used alongside any proper operational restructuring; no commitment from the supervisor of the CVA on the success of any CVA plan or strategy; and too narrowly being focused on disenfranchising landlords.

How can they work well?

CVAs can work well when they are part of a well constructed restructuring plan which has the buy-in of all stakeholders and is not just simply looking to target one group.

CVAs are a formalisation of an agreement between the company and its creditors to help compromise current and future liabilities with the ultimate aim of saving the business.  Therefore, for it to be successful, it needs to be implemented as part of a wider operational restructuring process which the creditors need to believe in.  Given that the directors of the company will continue to retain control of the business and deliver on these restructuring plans, creditors need to be assured that the plans are robust and have confidence in management's ability to deliver them.

As moratorium debts will need to be settled as part of the moratorium the key focus for CVAs will be the pre-moratorium debts not subject to a payment holiday. We expect there will be some interesting timing issues on when the moratorium commences and the level of creditors that are therefore captured by the payment holiday, for example just prior to the month end payment run could be the point at which trade creditors peak.

In conclusion, CVAs are an extremely flexible restructuring tool which can be used to help companies reconfigure their business models to meet the new norm. Inevitably this challenge will require the input of all stakeholders of the business and won’t be a simple exercise of just reducing costs, it will need companies to consider more widely their business propositions. The new legislation is very useful in helping provide the mechanism to  facilitate these discussions between the company and its stakeholders and ultimately saving the company.

Please get in touch with Zelf Hussain and Jane Steer for further information.

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Ipso facto

David Kelly and Toby Banfield

All companies have key supplier relationships absent which the business would have great difficulty in continuing to trade. These key suppliers have in the past been able to use this leverage to gain a preferential position over other suppliers. These tactics have included demanding that pre insolvency arrears are met, prices are increased post insolvency or in some recent instances that the insolvency practitioner underwrite the redundancy costs the supplier would suffer as a consequence of the insolvency of the company. 

The Bill has now extended the application of S233 to include all supply contracts with some carve outs for finance contracts. The extension applies to all relevant insolvency procedures which includes both the newly introduced moratorium as well as other insolvency processes such as administration or liquidation. The new provisions specifically prohibit suppliers being able to use an insolvency procedure as a means of terminating a supply contract with a company, although the ability to terminate by giving the required contractual notice or for other breaches is not affected. It also restricts the ability of suppliers to demand arrears are settled as a condition of ongoing supply.

In recognition of the impact that insolvency has on smaller suppliers, there is currently a COVID-19 temporary exemption for small businesses. These are defined as those that have sales of less than £10.2m, total assets less than £5.1m or less than 50 employees. 

The Bill does offer some protection for suppliers by deeming that supplies made to a company during the moratorium must be paid for and one of the tests for any extension of a moratorium is that debts incurred during the moratorium have been paid or otherwise discharged. In the event of a subsequent insolvency there is priority afforded to any unpaid moratorium expenses.

Financial services and hire purchase contracts are expressly excluded from these extended provisions. We expect that credit card and merchant facilities will also be caught within the definition of financial services. Prior to COVID-19, one of the challenges for consumer-facing businesses was the actions of credit card companies increasing the level of cash hold back and restricting the free cash available to the corporate. There may potentially be some challenge in this area. 

Overall the changes to these clauses are very welcome and should increase the liquidity available to directors during the moratorium period and insolvency practitioners who are trying to use the available cash to help maximise returns to creditors as a whole. 

Please get in touch with David Kelly and Toby Banfield for further information.

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Wrongful trading

Peter Dickens and Ross Connock

The COVID-19 pandemic has brought into sharp focus the responsibilities of directors. Directors are facing great challenges trying to assess the impact of the pandemic on their financial position and the extent to which the position will improve when lockdown is lifted and the markets slowly return to a more normal state. This makes it very difficult for directors to assess whether their actions continuing to trade are worsening the position of the company and its creditors or whether they are creating a better outcome for all.

Recognising these challenges, the Bill has introduced temporary measures to remove the threat of personal liability arising from wrongful trading for the period from 1 March 2020 to 30 June 2020 or one month after the Bill is passed into law (whichever is the latter). 

Liquidators and administrators will not be able to take an action against an insolvent company’s directors for any losses to creditors resulting from continued trading during the period whilst the wrongful trading rules are suspended.

Hopefully these measures will remove the pressure on directors to place businesses into insolvency that might have had a reasonable prospect of surviving absent COVID-19.

Please get in touch with Peter Dickens and Ross Connock for further information.

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Suspension of winding up petitions

David Baxendale and Mike Denny

Consistent with some of the other measures introduced to provide breathing space for companies affected by COVID-19, the Bill contains provisions to protect companies from threats from statutory demands or winding up petitions.

The Bill specifically prohibits the presenting of a winding up petition for registered and unregistered companies for the period from 27 April 2020 to 30 June 2020 unless the petitioning creditor is able to argue that COVID-19 had no financial effect on the company or that the grounds for the petition are not COVID-19 related.

Any winding up orders made after the 27 April 2020 where the financial pressures are COVID-19 related will be considered void.

These measures provide breathing space for companies and may enable them to use the moratorium in conjunction with these measures to develop and present a restructuring plan to creditors that will enable the company to continue as a going concern post restructure. 

Please get in touch with David Baxendale and Mike Denny for further information.

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Steve Russell

Steve Russell

Head of Business Restructuring Services, PwC United Kingdom

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