Restructuring law reform back on the agenda
The 2016 consultation on reforms to restructuring law appeared to have stalled due to the impact of Brexit on the legislative priorities of the Government. However, a silver lining to the Carillion collapse is a renewed focus on insolvency which has brought the proposed reforms back onto the agenda.
On 26 August the Government published a response to the consultation process initiated post-Carillion. The response sets out a range of proposed reforms, aimed at preventing major collapses, improving accountability and recovery of stripped value where collapses do happen and improving the tools available to companies to achieve rescue and restructuring. While a complete analysis of all proposals is beyond the scope of this insight there are a number of themes and issues which may have a significant impact on the market which are considered here.
Restructuring law reforms
In 2016, the Government consulted on four potential reforms to facilitate the restructuring and rescue of businesses. These were:
- a moratorium to give companies breathing space to pursue a restructuring;
- the ability for companies in a process to designate critical suppliers who would be obliged to continue to supply;
- a framework for the provision of rescue finance akin to US DIP finance; and
- a new restructuring process with the ability to cram down dissenting junior classes in a manner that CVAs and scheme currently cannot achieve.
Of these, the Government has moved away (rightly, in the view of this insight) from a specific rescue finance framework beyond what insolvency priorities of payment currently enable, and is moving forward with the remaining three proposals to various extents.
The Government notes the practice of using successive notices of intention to appoint administrators as a means of protecting a company seeking a restructuring, and that the courts have held this practice as invalid. A pre-restructuring moratorium is aimed at resolving the need for this practice, but will the proposal be successful?
The proposal provides for a moratorium similar to that available on administration to be obtained by an out of court filing, for an initial period of 28 days subject to extension. The moratorium would be monitored by an insolvency practitioner as supervisor to ensure that creditors are not prejudiced and the supervisor is obliged to terminate the moratorium if the company is not able to meet its current liabilities. While more detail of exactly how the moratorium will work is required, the following points of note come out of the present position set out by the Government:
- The moratorium will not be available to a company that is “insolvent” and requires the company to continue to meet its current liabilities while the moratorium is in place. This suggests that the role of the moratorium might be limited to protecting the company from financial creditors while seeking a financial restructuring, or where a restructuring of trade liabilities or rents is proposed, this will only be forward-looking. Although this arguable deems a company as “insolvent” and hence ineligible, it would seem sensible and consistent with other processes that the moratorium could be used as a defence against overdue debts pre-dating the period and this will need to be clarified when the precise conditions for invoking the moratorium are met.
- This also suggests that the practice of filing multiple notices of intention will be eliminated entirely. A company may still require more than 10 working days' protection when seeking to plan an effective administration or pre-pack. However, in these circumstances use of the moratorium would seem difficult for the supervisor to approve, unless current liabilities are kept current, in what may be a preferential manner.
- The requirement for the supervisor to certify the ability of the company to trade without prejudicing creditors is one of the reasons that the exiting small companies moratorium has been less used than might have been expected. It remains to be seen whether the risks attendant for the supervisor is mitigated by the ability to terminate sufficiently to make a supervisor role an attractive one to take.
- Potentially exacerbating the unattractiveness of the role of supervisor is that the supervisor would be precluded from taking an administration appointment if the restructuring being sought is not successful. In practice, this could be a useful safeguard as it would encourage the use of a moratorium where there is a genuine restructuring prospect. However, it may make the moratorium unavailable in borderline cases, where it would be of most use.
- The answer may lie in the identity of the supervisor. While the initial position is that this must be a licenced IP, the Government reserves the ability to extend qualification without primary legislation. This could open the door to the role of supervisor being taken by turnaround professionals or lawyers.
Designation of essential suppliers
The Government has previously proposed that in a moratorium or an administration, a company should be able to designate suppliers as critical such that they would be obliged to supply during the term of the moratorium or administration subject to be paid or their debts having appropriate priority on insolvency. At first blush, this was a laudable attempt to block the use of a ransom position to leverage a better deal out of a company in distress.
That being said, it is clear that being forced to continue supply where there may be significant outstanding debts could present a significant challenge and hardship for small suppliers, particularly against the backdrop of risking losing a major customer. It was originally proposed that court oversight and the ability to appeal a designation as critical would resolve this, although the time and cost of bringing such an application may make this prohibitive.
This is an area where the original proposals have been watered down. Rather than a company being able to designate critical suppliers that must continue, the Government proposes to block termination based on insolvency (including use of the moratorium). This would not preclude other bases of termination, such as non-payment so in practice, it may be that this would provide limited protection as insolvency will rarely be the only trigger for termination.
It is a difficult balance to draw but in the view of this insight, the presence of a supervisor or administrator in an oversight role could have provided an adequate safeguard to avoid abuse and the weakening of the reform in this area could be seen as a wasted opportunity.
New restructuring process
Further clarity is required as to exactly how the new restructuring plan would work but all indications are that while a new standalone process, it will function broadly in the same manner as a scheme of arrangement with the added ability to compromise junior classes.
The Government proposes that the cram down of junior classes should be based broadly on an absolute priority rule, where no class receives payment if the class above is not paid in full and that this principle should only be deviated from if it can be demonstrated to the satisfaction of the court that this is necessary to achieve the aims of the restructuring and is just and equitable.
While this mechanic may develop further, as currently difficult to see how this would work in practice. This would require creditors above the value break to remain unimpaired and on its face could result in a situation where the existence of a junior secured class of creditors means that unsecured creditors key to the ongoing business would need to be left unpaid unless the court can be satisfied.
This issue aside there is a clear benefit in developing the flexibility of the current restructuring tools available to enable a cram down to be achieved solvently.
The key question and area for challenge will be that of valuation and of setting the level at which value breaks. This will always be an element of estimation unless a full marketing process has been run, but an interesting development compared with case law on schemes is that the valuation comparator is proposed to be the "next best alternative" rather than a liquidation outcome. This seems a logical and sensible approach in the circumstances.
Improvements to insolvency framework in the case of major failure
The post-Carillion consultation deals with a number of initiatives in relation to corporate governance, to strengthen the skillset of directors and increase the level of involvement and stewardship of shareholders. In addition, certain proposals are made to deal with the aftermath of a failure, to challenge value extraction schemes and hold directors to account on dissolution and for the sale of insolvent subsidiaries.
Extending powers to investigate directors to dissolution as well as liquidation closes a clear loophole while proposals around value extraction relate to tightening existing antecedent transaction controls, as well as modernising the way dividends can be declared.
More interesting is the proposal to hold directors of a selling company liable for a subsequent insolvency of the disposed subsidiary. This provides for directors of the selling parent to be liable for the losses of the disposed subsidiary where:
- at the time of sale, the subsidiary is insolvent or would be insolvent but for guarantees provided by other group companies or directors;
- the subsidiary enters administration or liquidation within one year of completion (reduced from two years based on responses to the consultation);
- the interests of the creditors of the subsidiary have been adversely affected in the intervening period; and
- at the time of the sale, the directors of the parent could not have reasonably believed that the sale would lead to a better outcome than immediate insolvency.
This proposal runs counter to the principle of limited liability and appears to be reactive to high profile failures rather than being grounded in principle. Responses to the consultation have highlighted the clear conflict that this places the holding company directors in between the interests of stakeholders of the company that they are directors of and those of the subsidiary. The Government response that such conflict will not exist where legislation requires directors to act with the interests of the subsidiary in mind do not convincingly address this point.
It would seem more appropriate to place the onus for deciding the solvency or otherwise of the subsidiary at the door of the directors of that entity. If the sale to a new shareholder will be prejudicial to creditors compared with an immediate insolvency then this is a decision for the subsidiary directors to make.
On the contrary, these proposals could severely hamper the ability to achieve the rescue of distressed businesses and could impact the opportunities available to distressed investors to purchase stressed businesses to seek to unlock value from turnaround, where the shareholder directors are disincentivised to sell and risk liability a turnaround plan entirely outside of their control is unsuccessful.
The Government acknowledges that the measures should not result in deterring legitimate business rescue so it is possible that there will be further clarification or amendment to mitigate the risks of the suggested approach, but as matters stand, unlike other proposals, this is not a reform that this insight considers necessary or desirable.
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