This year saw the introduction of the Corporate Insolvency and Governance Act 2020 (CIGA), one of the most significant Acts to reform the insolvency framework in the UK for years. While it is always hoped that business owners won’t have the need to look to insolvency legislation, the reality is that with the current economic climate, more and more businesses are finding they need to assess their position and safeguard their business from unexpected strains brought about by the COVID-19 pandemic. The legislation contains temporary changes, designed to support struggling businesses dealing with COVID-19 and it also contain some key new permanent changes.
Here, Eleanor Stephens, a recovery and insolvency solicitor with Harper James provides her advice on the three most important permanent changes introduced under the CIGA. And, via her 20 years of experience in covering all aspects of insolvency she sets out the advantages and disadvantages in each area.
What’s changed under the Corporate Insolvency and Governance Act?
There are three important permanent changes introduced under the CIGA:
- a new moratorium process;
- a new pre insolvency rescue and reorganisation procedure (the restructuring plan); and
- a ban on the use of termination clauses in commercial contracts on the basis of insolvency.
The moratorium is a short-term process where an eligible company, with certain key exceptions, does not have to pay debts that fell due prior to the moratorium for as long as the moratorium applies. This is initially 20 business days, but can be extended. The moratorium prevents the enforcement of security (other than financial collateral), the bringing of insolvency or other legal proceedings against the company, and forfeiture of a lease. The company will still have to pay debts falling due during the moratorium.
The moratorium can only be used where the directors are of the view that the company is, or is likely to become, unable to pay its debts; and a proposed monitor (see below) is of the view that it is likely that the moratorium would result in the rescue of the company as a going concern.
Advantages of the moratorium include the fact it could provide a very useful tool for giving the company breathing space from hostile action by landlords or suppliers. It may also allow a company time to formulate a rescue plan. This process should be low cost (compared with, for example, an administration).
However, there are disadvantages too. While the directors will remain in control of the company, for the duration of the moratorium, a ‘monitor’, who must be a licenced insolvency practitioner, will be in place. Many debts are excluded from this payment holiday, including wages and salary, and if there is a formal insolvency event within 12 weeks of the end of the moratorium, those debts take ‘super’ priority. Given the exclusions from the payment holiday provisions for financial contracts, it is likely that a company could only use the moratorium with the support of its financial creditors.
The Corporate Insolvency and Governance Act updates the Companies Act 2006 (CA 2006) by the introduction of a ‘Restructuring Plan’. This new reorganisation measure is similar to a scheme of arrangement, which many companies already use successfully to restructure their debts. Creditors and/or members are divided into classes based on the similarity of their rights prior to and as a result of the restructuring plan, and then vote on the restructuring plan. Subject to certain criteria on voting, and that the restructuring plan delivers a better outcome than the ‘relevant alternative’ (which will often be liquidation or administration), the restructuring plan will become binding on creditors or members in all classes if sanctioned by the court.
It is important to note that there are two main conditions of eligibility:
- The company has encountered, or is likely to encounter, financial difficulties that are affecting, or will or may affect, its ability to carry on business as a going concern.
- A compromise or arrangement is proposed between the company and its creditors, the purpose of which is to eliminate, reduce or prevent, or mitigate the effect of the financial difficulties mentioned.
The advantages in this area are that it should give many struggling companies which have viable underlying businesses the tools needed and necessary breathing space to secure a rescue. Plus, the availability of a restructuring plan is not dependent on the company’s size or turnover.
The restructuring plan has been introduced under company law not insolvency law, which not only might reduce the stigma of an insolvency procedure, but may also impact on other ways such as whether the restructuring plan triggers insolvency-related events of default in the company’s contracts, for example if it would be considered a qualifying ‘insolvency event’ under pensions legislation for the purposes of triggering the start of the Pension Protection Fund (PPF) assessment period.
However, disadvantages exist too, including the fact it may take time and requires the cooperation of many creditors/shareholders.
Ipso Facto/Termination Clauses
The CIGA 2020 introduced new provisions to ensure the continuity of essential supplies and to restrict contractual termination provisions on insolvency. These are sometimes known as ‘ipso facto’ clauses.
When a company is in an insolvency process, creditors often try to improve their position by threatening to terminate their supply of goods or services to the company, or refusing to continue supplying the insolvent company unless it agrees to settle any outstanding debts owed to it first. They can do this if the contract contains a provision allowing the creditor to terminate on the grounds of insolvency or the impaired financial position of the counterparty.
Under the new legislation, suppliers of goods or services are no longer able to rely on contractual clauses allowing for termination in the event of the counterparty’s insolvency or restructuring. This includes not only where the counterparty is subject to an existing insolvency process, but also covers if the company has entered either the new restructuring plan or moratorium created by the CIGA 2020. There is an exception when a company enters into a scheme of arrangement under Part 26 of the Companies Act 2006, where such termination clauses remain enforceable.
There are various carve outs from the new provisions, including insurers and where either the company or the supplier are involved in financial services. Financial contracts are also carved out, meaning for example that a lender is able to stop the supply of committed financing as a result of an insolvency event of default.
A creditor may apply to court for relief if continuing to supply goods or services would cause ‘hardship’.
Note however that these new provisions only apply to contracts for the supply of goods or services, so would not apply to commercial contracts generally e.g. to customers of the company. Also note that there is a temporary exemption for small company (or small LLP or individual) suppliers during the current covid crisis. This temporary exemption lasts until 30 March 2021.
Removing these clauses have their advantages. For instance, a creditor is unable to insist on payment of pre-insolvency debts in order to secure future supplies or insisting on less favourable payment terms. This can preserve key supplies to enable rescue.
They have retrospective effect in that they apply to any supply contracts that the company entered into both before and after the new provisions became law.
The obvious disadvantage is if you are a supplier to a company. However, there are some important safeguards that creditors can use, such as negotiate stricter terms in advance and be less willing to waive breaches. It is still possible to terminate for grounds other than the insolvency or restructuring. For example, you can terminate for breach of contract or provide for the contract to terminate on default. You could request personal guarantees from directors.
These reforms will inevitably bring about significant transformation in the way businesses and creditors interact with each other when financial difficulties occur. They provide some much needed assistance for companies who are struggling but who want to avoid formal insolvency procedures if possible, but it remains to be seen how far reaching these are, and if they might have the knock on effect on the solvency of creditors. If any of these issues affect you and your business, and you would like more information on any of these matters, contact our recovery and insolvency team, or speak to one of our commercial solicitors.Eleanor Stephens
Are there any aspects of CIGA that appear favourable to suppliers?
Whilst the new legislation is quite clearly balanced in favour of customers encountering financial difficulties, there are a couple of points worth highlighting in relation to what suppliers are still permitted to do:
- It appears to be the case that common law rights to terminate a contract for repudiatory breach are still available to suppliers, along with an option to exercise rights to terminate for convenience if this is part of the contractual agreement.
- A supplier is still free to terminate a contract if their customer’s insolvency process has not yet commenced but is nonetheless on the horizon, and also in circumstances where the insolvency process has actually started – as long as termination is not as a direct result of that process.
As a supplier, what can I do to protect myself in light of these new measures?
It’s vital that you act now in reviewing all of your contracts closely, then take action in order to minimise the adverse implications that CIGA and the extended temporary measures may have on your business.
In addition to broader suggested measures such as taking out credit insurance and perhaps undertaking a more extensive due diligence exercise prior to contracting with potential customers, the following guidance may assist you if you need to go about making some changes in order to protect your company:
- Retention of title: ensure that you have retention of title provisions in place in your supply contracts, which should be worded so as to be exercisable prior to a customer’s insolvency.
- Termination clauses: ensure that these cover scenarios where non-payment is an issue, and termination for convenience with a short notice period.
- Contract terms: where possible, it may be advisable to reduce contract terms if this is something that would lend itself to the nature of your business.
- Payment terms: such terms ought to be transparent and rigorous, with consideration given to increased initial payments and shorter credit periods. Guarantees may also be an effective mechanism in the event that a customer begins to struggle financially.
- Financial health checks: consider implementing a requirement whereby customers have to provide updated information regarding their financial circumstances at specifically agreed intervals. Should this information not be provided when requested, or if it acts as a red flag to an insolvency process which may be looming, a term allowing termination in such cases ought to be included in the contract.