COVID-19: OPTIONS AND PROTECTION AVAILABLE TO COMPANIES IN DISTRESS
Directors will naturally be concerned as to their conduct during the current pandemic. Trying to do the right thing by the company’s employees, customers, suppliers and other stakeholders whilst ensuring ongoing compliance with their fiduciary duties will be challenging, however, changes have been made to the insolvency regime to provide directors with breathing space to explore their options.
Administration as a stability and restructuring mechanism
The Insolvency Lawyers Association (“ILA”) have been working to mobilise a fast-track ‘light touch’ form of administration to stabilise, protect, and, if necessary, restructure companies.
Administration is a rescue tool, which allows the company to continue to trade whilst providing a legal moratorium protecting it from creditor enforcement. Although relevant statutory provisions provide that an officer of a company in administration cannot exercise a management power without the consent of the administrator, the administrator can decide to delegate a whole host of management powers to the company’s directors. It seems likely that there are many cases arising out of the COVID-19 crisis where this would be appropriate.
This form of ‘rescue of the company as a going concern’ administration is not going to be appropriate in all cases, however, in the right circumstances can provide a company with additional breathing space to enable all of its options to be considered before implementing the most appropriate strategy.
New moratorium for companies
The government have introduced the Corporate Insolvency and Governance Act 2020 (“CIGA”) which included a free-standing short moratorium preventing creditors from enforcing debts during that period. The moratorium will initially last for 20 days but could be extended for a further 20 days in certain circumstances. Further extension would require the approval of 50% of secured and unsecured creditors.
Whilst this is a welcome change the qualification criteria is restrictive. Only companies which are financially distressed but viable are presently set to benefit from the moratorium. A company must be able to demonstrate it has sufficient funds to pay creditors accrued during the moratorium period. It is expected the process must be monitored by an Insolvency Practitioner who will need to be satisfied that the qualifying conditions are met. Creditors will have the right to challenge on the basis qualifying conditions are not met or they would be unfairly prejudiced by the moratorium.
Temporary modifications relaxing the entry requirements such that companies subject to an insolvency procedure in the previous 12 months and/or is subject to a winding up petition, can still access the moratorium. These relaxed rules have been extended until 30 March 2021.
Exit from the moratorium is expected to be via an informal restructuring, Company Voluntary Arrangement, or Administration.
New restructuring plan
CIGA has also introduced a new restructuring procedure akin to a Scheme of Arrangement whereby smaller “out-of-the-money” creditors (amounting to less than 25% of overall liabilities) who are no worse off than in liquidation, can be crammed down and bound by an arrangement. Similar to a Scheme of Arrangement, the arrangement would require court approval.
Prohibition on termination (ipso facto) clauses
CIGA also legislates to prevent suppliers enforcing contractual termination clauses while a company is going through a rescue process. Suppliers can terminate the contract is if can demonstrate “undue financial hardship” and small suppliers are exempt from the obligation until 30 March 2021. Suppliers will have super priority for supplies made during the insolvency process to ensure continued supplies are paid for.
Suspension of s214 Insolvency Act 1986 – Wrongful Trading
The Companies Act 2006 (CA 2006) codifies most, but not all, of the duties imposed on directors by case law and equitable principles. There are seven general statutory duties, of which three are most relevant to companies in financial difficulties:
• the duty to promote the success of the company for the benefit of its members as a whole
• the duty to exercise independent judgment, and
• the duty to exercise reasonable care, skill and diligence.
When a company is financially distressed and becomes insolvent, or is unlikely to avoid insolvency, the directors’ duty to promote the company’s success (i.e. to act in the interests of the members as a whole) is replaced by a duty to act in the creditors interests as a whole (i.e. to preserve the value in the company in order to maximise the return to creditors).
In order to ease the burden on directors who may have been severely impacted by COVID and lockdown measures, the UK government have temporarily suspended the wrongful trading provisions during the ‘relevant period’. The relevant period originally ran from 1 March 2020 to 30 September 2020. On 26 November 2020, the government reinstated the temporary suspension on 26 November 2020 and is currently due to end on 30 April 2021.
It’s important to note however that this temporary suspension of wrongful trading should not be interpreted as a suspension of fiduciary duties and therefore Directors should seek advice from a qualified Insolvency Practitioner if they have concerns regarding the solvency of the business.
Suspension of serving statutory demands and restrictions on winding-up petitions
Statutory demands are automatically void if served between 1st March 2020 and 31st March 2021. Winding-up petitions presented between 27th April 2020 and 31st March 2021 are unlikely to result in a winding up order by the court unless the petitioner can demonstrate that the company’s inability to pay the debt was not as a result of Covid-19.
Ensure good governance
While the government had temporarily relaxed wrongful trading provisions, these restrictions have now ended, so directors now risk personal liability for wrongful trading and other offences. These could include general misfeasance, preference payments, transactions at undervalue and fraudulent trading.
If a business is in distress, directors should seek appropriate professional advice; in the form of an experienced licensed insolvency practitioner or insolvency lawyer, and take practical steps to mitigate these risks and ensure they make the best and most informed decisions for their businesses, including:
• Ensure all government mitigation measures, where appropriate, are implemented;
• Meet regularly and keep minutes of all meetings to support your decisions and thought processes;
• Ensure financial information is up to date including forecasts to help assess the impact of Covid-19 on working capital;
• Prepare a business strategy to document how the business will trade through the current disruption
• Monitor financial covenants and consult lenders about existing debt and any future requirements.
• Consider the impact of Coronavirus on the financial statements and extend the deadline for filing financial information, if required;
• Review existing commercial contracts and establish whether contractual obligations can be met.
• Satisfy obligations relating to the care of employees and safeguard their health and wellbeing;
• Consult with suitable professionals such as an accountant or insolvency practitioner.
Consideration needs to be given by the board as to whether adequate business resilience plans are in place. Should directors be found to breach their duties, they could be personally exposed to claims brought via civil and criminal actions.
Those involved in the running of a company should continue to seek appropriate professional advice if they are concerned about the viability of their business. If you have such concerns please contact us for a no obligation consultation to explore your options.