Corporate Insolvency Framework Reform - The Story So Far

Authored by Emma Lovell, CEO, R3, the UK Insolvency and Restructuring Trade Body

Read Upside - Autumn 2019

The package of reforms combines ideas from two different Government consultations: a set of 2016 proposals for boosting business rescue; and reforms from spring 2018, designed to address perceived governance and stewardship failings linked to a number of recent high-profile insolvencies.

The reforms are a mixed bag. Some are welcome; some are good ideas in principle, but require further work; and some need a complete rethink.

When exactly these reforms will be introduced is an unknown. Brexit has seen Westminster’s legislative gears grind almost to a halt; the Government says it will put the reforms to MPs “when parliamentary time allows.” That could be a long time coming.

In the meantime, however, it’s worth looking at the reforms as they are now: what’s being considered, and what problems still need fixing.

Business Rescue

Starting with the new business rescue tools for corporate insolvencies, they are:

• A business rescue moratorium, to give struggling businesses a 28-day “breathing space,” which would allow companies to put in place a turnaround or rescue plan free from the threat of creditor action;
• New measures to allow companies in a rescue procedure to continue to receive essential supplies; and
• A new court-based restructuring tool for both solvent and insolvent companies.

The Moratorium

The moratorium is a good idea in principle, and something R3 has long called for. In the current framework, struggling companies’ room for manoeuvre ahead of an insolvency procedure can be limited, with the threat of creditor action hanging over attempts to restructure. A moratorium could create some much-needed breathing space.

However, the Government’s proposals, as drafted, are problematic. There are tight limits on the companies that can use the process (among other entry criteria, the procedure is limited to solvent companies), while the oversight role isn’t exactly appealing. At the moment, we may end up with a moratorium which, like the current Schedule 1A moratorium, is little-used. 

Encouragingly, the Government has already shown a willingness to be flexible with its moratorium proposal. Since the policy was first proposed in 2016, the Government has shortened the moratorium’s length from three months to 28 days (to reduce creditors’ risk and to limit the chances of abuse) and has decided to limit the oversight role so that it can only be held by licensed insolvency practitioners. These have been welcome improvements to the original proposal, but more change is needed.

Termination Clauses

In order to ensure companies in rescue procedures continue to receive key supplies, the Government has said it intends to introduce new legislation, which will prevent the enforcement of “termination clauses” in contracts for the supply of goods and services where the clause allows a contract to be terminated on the grounds that one of the parties to the contract has entered a statutory insolvency procedure. While this is perhaps a limited tweak to the rules – it might be easy for suppliers to find other grounds not to supply – going any further may risk unintended consequences. By comparison, the Government’s original proposal was that company directors could designate “essential suppliers” who would be forced to continue to supply them in a rescue procedure. This proposal would have headed too far in the other direction, and there would have been a very real risk of abuse.

There are still some problems with the proposal to iron out. For example, licences are exempt from the new rules, which could spell trouble for companies in the hospitality or care sectors. It’s not clear why a company able to meet every regulatory requirement, except for solvency, should lose its licence to operate. It’s also unclear how “finance” will be affected by the changes to termination clauses: will things like overdrafts be exempt, or not?

Restructuring Tool

The Government has proposed the creation of a new court-based restructuring tool that will be available to both solvent and insolvent companies. This tool is designed to encourage early action from company directors to address financial difficulties and reduce stigma around insolvency.

At first glance, the tool looks like the U.S. Chapter 11 proceedings, but it would be more accurately described as a “copy and paste” of an English Scheme of Arrangement. The new tool is a cross-class cramdown procedure available to any company seeking to bind creditors to a restructuring proposal. Proposals will be reviewed and approved by creditors and the courts.

There will be limited prescription for what the restructuring tool can cover and the changes proposed by the plan can be economic and financial. The Government suggests that, among other things, the plan could be used for debt write-downs, debt postponement, a change in the management team or selling off loss-making parts of the company.

Corporate Governance

On the corporate governance front, the proposals of direct relevance to the insolvency and restructuring profession include measures to:

• Disqualify directors of parent companies who sold a financially-distressed subsidiary, which became insolvent within 12 months of the sale;
• Review insolvency practitioner powers to undo a transaction, or a series of transactions, which “unfairly” strip value from a company; and
• Extend the director disqualification framework to cover dissolved companies.

Subsidiary Sales

The proposal to disqualify directors if a sold subsidiary becomes insolvent within 12 months of the sale is a less draconian version of the Government’s original plan to make directors of parent companies financially liable for creditors’ losses if a sold subsidiary were to become insolvent within two years of a sale.

Despite the changes, the new rules could still act as a significant challenge to the UK’s reputation as a place to do business. Rather than selling subsidiaries in a “live” sale, parent company directors may find it less risky to simply close subsidiaries down, or they may opt to sell subsidiaries having first put them into an insolvency procedure. Neither would exactly improve the UK’s business environment, and it’s not exactly clear what positive outcomes the Government thinks the changes will achieve. While the Government’s desire to tackle perceived “reckless” behavior by directors is understandable, this proposal may end up doing more harm than good.

Value Extraction

Back in spring 2018, the Government proposed new office holder tools to reverse transactions, which had “extracted value” from a company prior to its insolvency. The pushback to this is that office holders already have powers to do this, but that case law, funding issues and a lack of creditor engagement make it difficult for these powers to be used. New powers wouldn’t actually fix any underlying problems. Helpfully, the Government has now promised to review office holders’ existing powers and look at how these might be improved. This review is welcome.

Director Disqualification

The measure to extend director sanctions to cover dissolved companies is one that R3 supports wholeheartedly. The proposal is designed to tackle situations where unscrupulous directors use dissolutions to avoid the scrutiny of an insolvency procedure. This is welcome, but the Government could go further here. While disqualifying directors of dissolved companies may act as a handy deterrent, it’s unlikely to be of much benefit to creditors affected by a director’s actions. As well as the expansion of the disqualification framework, the Government should also make it easier to restore a dissolved company so that it can be liquidated, and distributions made to creditors. While dissolution is currently an administrative procedure, restoration requires court intervention – both processes should be the same.

What Next?

There are plenty of good ideas in the Government’s proposals, although much more work is needed: the good ideas may not work in practice, while the “bad” ideas need further pruning.

It’s really important for the Government to get these reforms right. While the UK has long enjoyed a reputation as a global restructuring hub, we can’t stand still. Other countries are reforming their own frameworks, and we need to reform our own so that we can stay ahead of the competition. With Brexit presenting a challenge to the ease with which cross-border restructurings can be carried out from the UK, it’s now more important than ever that we have an up-to-date insolvency and restructuring framework. The sooner the Government makes progress, the better.