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Changes to the UK insolvency framework
The government announcement of 28 March does not provide details of the proposed changes to the insolvency framework, and instead cross-refers to the change to the corporate insolvency regime outlined in the August 2018 Department for Business, Energy and Industrial Strategy publication entitled “Response to the Insolvency and Corporate Governance Consultation" (the "BEIS Response").The BEIS Response is an outline of the government's proposed insolvency reforms, not a draft legislative package.
Key features of the proposed moratorium as described in the BEIS Response include:
- A company initiating a moratorium cannot already be insolvent but should be in a state of “prospective” insolvency.
- It must be more likely than not that a compromise or arrangement with creditors can be agreed.
- Directors would remain in control of the company during the moratorium, but a “monitor” (a insolvency practitioner) would be appointed to supervise the moratorium and to protect creditors’ interests.
- The initial moratorium period would be 28 days, extendable for a further 28 days, with further extensions being possible subject to creditor approval.
- The moratorium would affect both secured and unsecured creditors but would not affect the enforceability of financial collateral arrangements.
- Typical outcomes from a moratorium are expected to be that a company agrees an informal restructuring with creditors, or a company enters an insolvency procedure, either a rescue procedure, such as a CVA, or a liquidation procedure.
Key features of the proposed restructuring plan as described in the BEIS Response include:
- A company acting through its insolvency officeholders as well as a company acting by its directors would be able to propose a restructuring plan, but the plan could not be proposed by creditors.
- A restructuring plan proposal will be circulated to creditors and shareholders and filed at court.
- There will be a first hearing to examine the classes of creditors and shareholders proposed by the company, the formulation of which may be challenged by creditors and shareholders, who may also submit counterproposals.
- If the requisite voting majorities are met and the rules for imposing a cross-class cram down are complied with, the court can decide at its discretion whether to confirm the restructuring plan.
- A plan can be confirmed by the court even where one or more classes do not vote in favour, provided that at least one class of impaired creditors (i.e. who will not receive payment in full under the restructuring plan) votes in favour of the restructuring plan.
Consequently, suppliers will have to continue to fulfil their commitments under their contract with the debtor company.
However, suppliers would retain the right to terminate a contract on other grounds permitted by the contract including for non-payment.
The BEIS Response states that certain types of financial products and services would be exempt as special cases, although no further details are given.
We understand that the new rules (when announced) will differ from those previously published.
Implications for ISDA Master Agreements
If a company that is a party to a 1992 or 2002 ISDA Master Agreement enters into a moratorium or a restructuring plan, it is possible that these circumstances could constitute an Event of Default under Section 5(a)(vii)(Bankruptcy). These questions will need to be considered in light of the final text of the legislation.
If a moratorium constitutes an Event of Default, a counterparty could nonetheless be prevented from terminating the ISDA Master Agreement and/or enforcing its right to payment of an early termination amount by virtue of the moratorium. If exceptions are limited to financial collateral arrangements, enforcement of derivative contracts that do not qualify as financial collateral arrangements (ie. typically those contracts where collateral is not posted under a Credit Support Annex) would be subject to the moratorium. Given the application of the Uncleared Margin Rules, as a practical matter, this would mean that the primary universe of counterparties who can benefit from the moratorium in order to protect their derivatives positions will be UK non-financial counterparties.
Section 2(a)(iii) of the ISDA Master Agreement may provide some protection to the swap provider where it has not been disapplied if the onset of the moratorium would constitute a Potential Event of Default.
The issue is particularly relevant to finance-linked swaps where there is rarely a CSA (other than under rated structures below), and the swap provider is secured but has given up various standard rights to terminate the derivative. It is important that the swap provider under these financing arrangements does not become structurally subordinated to the lending syndicate as a result of these changes.
With a finance-linked swap in a rated structure (for instance, an RMBS or CMBS), there will be a one-way contingent CSA in place at the outset of the trade, although no collateral would be posted until a downgrade of the swap provider. This would categorise the arrangement as a financial collateral arrangement so that a moratorium should not prevent a termination of the swap in this case.
It is doubtful that the stay would be enforceable under an ISDA Master Agreement (or other document) which is not governed by English law unless the moratorium is capable of recognition and enforcement in that jurisdiction, for instance pursuant to US Chapter 15 proceedings.
Termination rights under ISDA Master Agreements may be affected by the provisions of the new framework concerning protection of supplies. This will depend on what types of supplies are captured by the new framework. It remains to be seen whether there will be specific carve-outs for hedging and other financial transactions.
Similar considerations would in theory apply to other master trading documentation but, for example the GMRA or GMSLA in securities financing, would be financial collateral arrangements and be exempt from the moratorium.
Implications for Credit Derivatives
If a UK Reference Entity enters into a moratorium or a restructuring plan, it is possible that these circumstances could constitute a "Bankruptcy" Credit Event or a "Restructuring" Credit Event, as the case may be. These questions will need to be considered in light of the final text of the legislation.
In the case of the moratorium, considerations that could be relevant to a determination of whether it is a Credit Event may include (i) whether or not the reforms are enacted under an insolvency law, (ii) the nature of the process required to commence a moratorium, and (iii) whether, in the case of transactions subject to the 2014 Credit Derivatives Definitions, the relief under the moratorium is sufficiently similar in effect to that of a judgment of insolvency or bankruptcy, taking into account, among other things, the degree of restrictions on creditors' rights and the role of the monitor.
Whether or not the occurrence of a moratorium is a Credit Event might be different where the trade has been documented under the 2003 Credit Derivatives Definitions as the Bankruptcy definition differs from that contained in the 2014 Credit Derivatives Definitions.
Where the determination of a Credit Event is referable to the ISDA Determinations Committee, a Credit Event as a result of a moratorium could result in the buyer losing its protection prematurely as the moratorium could be quite a soft form of insolvency.
We will update this alert as soon as we have more details of the proposed measures.
In the meantime. if you would like to discuss the implications of this alert or changes to the insolvency framework in the context of derivatives documentation generally, please get in touch with your usual Fieldfisher contact.
Dougall Molson
Guy Usher
Edward Miller
John Delamere
Emma Spiers
Steven Burrows
Gary Walker
William Hunnam
Jenny Warren