The Bill seeks to amend existing legislation (the Insolvency Act 1986 and the Companies Act 2006) in three principal ways:
Creating a more debtor-friendly or "debtor in possession" regime to assist corporate rescues with a statutory moratorium.
Introducing a new restructuring procedure.
Invalidating clauses in supply contracts that terminate for insolvency proceedings.
The COVID 19 pandemic has also brought in specific measures that temper existing wrongful trading liability and restrict the presentation of winding-up petitions.
The real estate finance market will need to look closely at these areas in the context of the specific needs of the asset class including as to their effect on borrower groups, tenants and building contractors among others.
On the lender side, this will lead to a change in the approach and timing of existing enforcement and asset realisation options that are available to creditors. On the borrower side, they may demonstrate welcome, if temporary, protection from such action and offer enhanced prospects for rescue and recovery - although stopping short of a full safety net.
Originally proposed in consultations stretching back to 2016, the business rescue moratorium has been extended and is to be made available to eligible entities that are, or are likely to become, unable to pay their debts, but where it is considered likely that, with the benefit of the breathing space afforded by the moratorium, the entity could explore options to restructure their debt position.
In turn, this breathing space should ultimately allow the entity to be rescued as a going concern – whether by a CVA, a restructuring plan or an injection of funds.
While it applies to "eligible" entities only, this will encompass the majority of vehicles used in real estate financings, including registered and unregistered companies, LLPs and overseas companies.
Provided the entity hasn't been subject to an administration process, a CVA or a moratorium in the previous 12 months, the directors or officers must form a view that the relevant entity is unable to pay its debts (there is no stipulation to say whether this should be through a balance sheet test or a cash flow test). The insolvency practitioner who will monitor the moratorium must then be willing to certify that the moratorium would likely result in the entity's rescue as a going concern.
The moratorium will last for an initial period of 20 business days but may be extended without creditor consent for a further period of 20 business days and with creditor consent, or by the court, for up to a year or more. If a CVA is proposed during that period, the moratorium is pushed out further until the CVA meeting is concluded.
The practical effect of the moratorium is two-fold. It creates a payment holiday for pre-moratorium debt (i.e. debt falling due before the moratorium, or during the moratorium pursuant to an obligation that pre-dates it) and also prevents enforcement of those debts, including blocking insolvency proceedings and other legal action by secured creditors (including winding-up petitions).
Certain debts are however excluded from the payment holiday including;
(i) rent "in respect of a period during the moratorium"; which insolvency lawyers are taking to mean rent accruing on a daily basis during the moratorium period as opposed to all rent falling due within that period, in line with administration rent obligations ("rent" in this context is not yet clear, insofar as it may extent to other payments under any lease but service charges are thought to be included); and
(ii) debts or other liabilities arising under a financial services contract (including loans and other indebtedness, such as finance leases). As presently drafted, this would appear to include arrears, and if accelerated, the entire sum would become a super-priority moratorium expense. The definition of non-payment holiday debts (NPHDs) is one part of the Bill that may yet get amended in its passage through the House of Lords before becoming law.
Development financers should also note that bills for goods or services supplied and wages and salaries incurred during the moratorium period must continue to be paid.
Save for NPHDs, pre-moratorium debts can only be paid with the consent of the insolvency practitioner monitoring the moratorium, or the court.
In terms of enforcement and other proceedings, without court permission:
Landlords are prevented from forfeiting by peaceable re-entry. This is of course additional to the provisions of the Coronavirus Act 2020 that prevent forfeiture before 30 June 2020 (and which may be extended).
Security cannot be enforced (except in respect of certain financial collateral (shares/cash where the security fulfils certain criteria) within the Financial Collateral Arrangements (No.2) Regulations 2003).
Floating charges will not crystallise to prevent the disposal of floating charge assets.
No new security can be created during the moratorium (without the monitor's consent).
No legal proceedings can be taken including for commercial rent recovery.
Should the entity nevertheless become insolvent or otherwise be unable to pay moratorium period debts or NPHDs (such as rent), then the monitor is obliged to terminate the moratorium. Similarly, the moratorium will end if the directors seek to put the entity into administration or liquidation.
The Bill introduces a new legislative rider to the Companies Act 2006 that enables companies in financial difficulty to propose a restructuring plan that allows it to it to compromise creditors or its members or classes of creditors or members. The restructuring plan scheme can be invoked by any company that can be wound up under the Insolvency Act 1986, including overseas companies.
The idea is that the restructuring plan offers an alternative to CVAs and schemes of arrangement but at the same time, it leverages much of the existing legislative machinery.
In order to propose a restructuring plan the entity must meet two key conditions:
that it 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; and
a compromise or arrangement is proposed between the company and (a) it creditors, or any class of them, or (b) its members, or any class of them, and the purpose is to eliminate, reduce or prevent, or mitigate the effect of any such financial difficulties.
The process for approving a restructuring plan has some synergies with the process followed for schemes of arrangement, requiring application to court and summoning meetings of the relevant (affected) creditors and members. In fact, much of the legislation is a direct copy of that for schemes of arrangement, and it remains to be seen if the significant cost associated with schemes can be avoided in this process.
If 75% (by value, not by number) of the creditors (or members) who vote agree a restructuring plan, the court may sanction that arrangement. Dissenting creditors will not scupper the plan necessarily and it may still be sanctioned if:
the court can be satisfied that the dissenting class would not be any worse off if the plan isn't sanctioned; and
the compromise has been agreed by 75% of the creditors (or members) (again, by value, not a simple majority by number) who would be eligible to receive a payment or who have a genuine economic interest in the company.
Once agreed by the court, the restructuring plan would bind all creditors and members as well as the company – and in doing so, this "cram-down" effect may differ from a scheme of arrangement. Subject to court approval, parties who are out of the money, such as mezzanine or junior lenders for example would be unable to block the restructuring.
Despite the creation of a new regime, its application to tenants and the ability to cram-down landlords as a dissenting class or creditors is relatively unlikely. In this regard, we anticipate the current trend for CVAs as a means of leveraging rent reductions, particularly in the retail sector, to continue.
In addition, in practice where there are different tiers of creditor in the capital stack, the approval of any Restructuring Plan is likely to cause some contractual wrangling under Intercreditor Agreements. Depending on the drafting, it is possible that approval of a Restructuring Plan would count as "Enforcement Action" and which would bring into play different rights (voting and otherwise).
Indeed some Intercreditor Agreements may contain wording that require the mezzanine to vote in accordance with the senior where the vote is "by or under the supervision of any judicial or supervisory authority in respect of any insolvency, pre-insolvency or rehabilitation or similar proceedings relating to any Debtor" [see for example Clause 9.3 of the LMA REF template ICA] and intercreditor provisions will need to be analysed carefully on a case by case basis.
Preventing suppliers from terminating due to insolvency (ipso facto clauses)
The Bill includes measures that, with certain exceptions, invalidate termination provisions in contracts for the supply of goods and services that are triggered (in any way) by the customer entering into an insolvency process.
The exceptions include where an insolvency practitioner appointed over the company agrees, or where the court considers this would cause the supplier financial hardship. Certain "small suppliers" are also protected where the insolvency has occurred within a defined window around the time the Bill comes into force. There are some additional provisions that prevent suppliers demanding charged incurred pre-insolvency as a condition of maintaining supply. Finally, financial services supply contracts are also excluded (that is, where the insolvent customer is a bank, financial institution or payment services provider).
These measures build on existing protections that enable essential services to continue to be provided (such as utilities). In a real estate context we would expect these provisions to activate to ensure that critical property services are maintained and functional, allowing, for example, serviced buildings such as offices, apartments and hotels to continue to operate to the extent that service providers are unable to terminate for insolvency. Much will depend however on how the arrangements are structured, including whether by way of a lease arrangement which may take it out of the ambit of a servicing agreement.
Similarly contractors and suppliers on construction projects are likely to have to continue to honour their commitments to supply and service the site despite a developer's or employer's insolvency.
However it should be noted that in all cases the termination provisions are invalidated only as a consequence of the customer's insolvency and there is no apparent reason why a contract could not be terminated on another basis, such as non-payment or breach, after the start of insolvency proceedings. Given this, most insolvency lawyers believe this provision will be of limited effect.
In response to the COVID-19 pandemic the Bill seeks to offer certain relief to companies and directors that may otherwise be subject to liability for wrongful trading during a period of financial hardship as well as the prospect of being subject to winding-up petitions.
The provisions do not amend the existing regime under which a director may be liable for wrongful trading but rather they add an additional limb to the liability such that it may be suspended for a particular period. The period is restricted to that between 1 March 2020 and one month after the Bill comes into force (the relevant period), and which may be shortened or extended by up to six months by further regulations.
Directors of relevant businesses (excluding the financial sector) will be comforted by the blanket exception that courts must assume a director is not responsible for any worsening of the financial position of the company or its creditors during the relevant period. Significantly, there is no requirement to show that the deterioration of the company’s financial position was actually due to the pandemic. However, there remains a concern that directors that would otherwise be liable to a wrongful trading claim (which are themselves very rare) would remain culpable for breach of duty. Therefore, this provision is thought by many to be a useful sound bite more than actual protection for directors.
Restrictions on winding-up petitions
The Bill provides for the following temporary restrictions in relation to winding up petitions, which may be used as a particularly aggressive debt-collection device. Again the measures are expressed as a temporary adjunct to the existing winding-up provisions and are not an amendment. In particular, they provide that:
no petition can be issued
based on a statutory demand served in the relevant period
from 27 April 2020 until one month after the Bill becomes law, unless the creditor has reasonable grounds for believing either (a) the pandemic has not had a financial impact on the company; or (b) the debt would have arisen even if the pandemic had not had an impact on the company
any winding up order made between 27 April 2020 and the Bill coming into force and which would not have been made had the Bill been in force (as determined by a court) will be void.
Typically as soon as bank is made aware of a winding up petition an account will be frozen. However, due to the way the restriction has been drafted (including measures restricting the advertising of petitions during the relevant period and deferring the commencement of liquidation), a company will be able to continue to trade, and operate without needing to seek a court's permission. For that reason, banks should be comfortable to proceed and operate an entity's accounts during the relevant period.
It is clear that the government has taken significant steps to create breathing space for companies in financial distress but at the same time has sought to safeguard a functioning economy by ensuring suppliers continue to be paid. There will be inevitable tensions in trying to achieve these somewhat conflicting aims.
Although the government had the benefit of an existing programme of reform and consulted legislation to build from, the speed at which the measures are being deployed brings with it an unavoidable lack of detail.
As such, even where the legislation seeks to avoid court processes, much is still left to courts to decide what can and can't happen in terms of payment and enforcement and we anticipate a busy period ahead as stakeholders across the real estate finance industry navigate the new regimes.
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