Following on from my last blog, I wanted to provide a detailed analysis of the moratorium process that was introduced last month in the Corporate Insolvency and Governance Act 2020 (“CIGA20”). This is the first time that a debtor in possession style process has ever been introduced in the UK, but will it work and will it be widely used?
I can’t help but feel that this process will be better suited, along with the Restructuring Plan introduced at the same time, to large corporates and UK PLC. This is somewhat surprising given the economy is underpinned by SMEs, and in particular owner managed businesses (1).
Whilst a debtor in possession process had been the subject of much debate by the insolvency community, the Government were faced with the unenviable task of fast tracking the moratorium into new legislation as part of a package of measures to counteract the damaging effects of Covid-19. During this blog we will touch on the inflexibility of the Moratorium, its limited scope, the issues that a monitor faces and a new class of creditor with post moratorium super priority. The Government has repeatedly mentioned that this is here to stay so Insolvency Practitioners will all have to adapt, with the help of case law, in using this new tool as part of our considerations when helping companies.
Effects of the Moratorium
A company in a moratorium is entitled to a payment holiday in respect of its “pre-moratorium debts”. However, the definition of pre-moratorium debts excludes the monitor’s costs, any goods and services supplied during the moratorium which includes rent too, wages and salaries (including any redundancy payments), and debts or other liabilities arising under a contract or other instrument involving financial services.
It is important to note that during the moratorium the company must continue to pay (i) all its debts incurred during the moratorium as they fall due and (ii) all its pre-moratorium debts for which it does not have a payment holiday as they fall due. So a company must continue to pay its banks and other lenders throughout the moratorium, whilst trade creditors and landlords can remain unpaid in respect of any arrears incurred before the moratorium takes effect.
During the moratorium:
- no insolvency proceedings may be commenced against the company;
- a landlord may not forfeit a lease by peaceable re-entry;
- no steps may be taken to enforce any security over the company’s property (unless it is a security created under a financial collateral arrangement or with the court’s permission);
- no steps may be taken to repossess any goods in the company’s possession under a hire-purchase agreement (except with the court’s permission);
- no legal proceedings may be commenced or continued against the company or its property (other than employment tribunal proceedings);
- a floating charge will not be crystallised and any chargee is prevented from causing the floating charge to crystallise. This preserves a company’s ability to dispose of its floating charge assets in the ordinary course of business during the moratorium. However, the company will not be entitled to dispose of other charged property unless the court permits.
Eligibility for a Moratorium
Companies and LLPs can apply for a moratorium, although financial services related entities (such as insurers, banks and investment firms) are ineligible.
Obtaining a Moratorium
The court may make an order only if it is satisfied that a moratorium for the company would achieve a better result for the company’s creditors as a whole than would be likely if the company were wound up. To obtain an order, the directors need to make a statement that the company is or is likely to become unable to pay its debts as they fall due; and the monitor must confirm that it is likely that the moratorium would result in a rescue of the company as a going concern.
Duration of a Moratorium
Initially the moratorium will be for a period of 20 business days, unless extended by the directors for another 20 business days, either with or without creditor consent. Further extensions are possible with creditor consent (for up to a maximum of one year duration) or the consent of the court. For each extension, the two qualifying conditions referred to above for obtaining a moratorium must continue to be met. The moratorium can also be extended where the company is proposing to enter into a CVA, a Scheme of Arrangement or a Restructuring Plan.
Management control during the Moratorium
Being a debtor in possession procedure, the company’s management remains in full control of the company. However, the monitor is appointed to provide oversight and safeguards for creditors. The monitor has a duty to monitor the likelihood of rescue of the company as a going concern. If the monitor considers that a successful rescue is unlikely to be achieved, the monitor must take immediate steps to terminate the moratorium.
The role of the monitor
The monitor must be a licensed insolvency practitioner. The monitor’s role is to ensure the conditions for the moratorium to be in place continue to be met and to protect creditors’ interests. The monitor’s purpose is to monitor the company’s affairs for the purposes of forming a view as to whether it remains likely that the moratorium will result in the rescue of the company as a going concern.
The commentary in this area is that it is supposed to be a “light touch” approach. It is not clear how much work the monitor will be expected to undertake to form the view that the moratorium is likely to result in the rescue of the company as a going concern. It may be that as an officer of the court high professional standards will be expected in this regard. It is likely that the boundaries of this test will need to be established by the courts, and there is already some debate as to whether “likely” should be interpreted more akin to a “reasonable prospects” test. In any event, any proposed monitor will want to satisfy themselves that there is a deliverable plan in place for the rescue of the company as a going concern, rather than the moratorium process being used on a speculative basis.
Moratorium debts in any subsequent insolvency proceedings
As noted above, the company must pay its moratorium debts and pre-moratorium debts for which it does not have a payment holiday during the moratorium as they fall due. If any of such debts remain unpaid and the company goes into a subsequent procedure (such as a CVA, administration or liquidation) which begins before 12 weeks after the moratorium ends, these moratorium-related debts will have super-priority in the subsequent procedure. Lenders to a company in a moratorium cannot obtain a super-priority for their debt in a subsequent insolvency process if they accelerate that debt during the moratorium.
It is likely that the monitor will have to very carefully consider their involvement with the company and in accordance with the recently updated Code of Ethics, whether to accept the appointment of any subsequent insolvency process. On the one hand, the monitor will be familiar with the company’s business and arguably this should keep any duplicate costs to a minimum. Alternatively, in the event that creditors have been unfairly prejudiced by a moratorium being allowed to continue when it shouldn’t have done, who is going to challenge the role of the monitor?
Creditors can challenge the actions, omissions or decisions of both the monitor and the directors of the company on the basis of unfair prejudice. The court can make such order as it sees fit, including terminating the moratorium, but interestingly cannot make a compensation order against the monitor.
In general terms, the moratorium provides a welcome additional tool for corporate rescues. However, given the fact that 40 business days will come and go in a flash whilst trying to restructure the company and that debts incurred during the moratorium, and certain key pre-moratorium debts must continue to be paid, the scope for companies to make use of the moratorium are more limited than perhaps initially intended.
I mentioned earlier that this may be more widely used by large corporates and UK PLC. This is because normally the gearing of SMEs tend to involve a single lender, supported by security over the assets of a company and, in some cases, a personal guarantee. Often there is a good dialogue between the lender and the company, and a greater likelihood of short-term assistance being available to bridge any cash flow difficulties, obviating the need and costs of a moratorium. Conversely, the breathing space provided by a moratorium will enable a company with complex debt structures to negotiate with multiple lenders to identify a rescue package taking into account the different ranking lenders competing needs.
Finally, given the requirement that a rescue of the company on a going concern (rather than parts of the business) has to be likely, it will mean that the moratorium cannot be used as an initial process to stabilise a company’s position and then to subsequently pivot into a distressed business sale, whether through a pre-pack administration or otherwise. Where a monitor cannot satisfy themselves that the rescue plan is capable of delivery or elements of the business are beyond rescuing, perhaps Administration may be a more appropriate tool to consider.
(1) Data regarding SMEs
- There were 5.9 million small businesses at the start of 2019. Compared with the previous year, the private sector business population increased 3.5% (+200,000 businesses).
- This consisted of;
- 5.82 million small businesses (with 0 to 49 employees)
- 35,600 medium sized businesses (with 50 to 249 employees)
- 7,700 large businesses (250+ employees)
- SMEs account for 99.9% of the business population (5.9 million businesses).
- SMEs account for three fifths of the employment and around half of turnover in the UK private sector.
- Total employment in SMEs was 16.6 million (60% of the total), whilst turnover was estimated at £2.2 trillion (52%).
Source – A Statistical Release dated 10 October 2019 headed “Business Population Estimates for the UK and the Regions 2019” by the Department for Business, Energy & Industrial Strategy.