The U.K. government has announced sweeping plans to reform its restructuring and insolvency regime, in what one legal expert has described as a potentially "seismic" change. The proposals aim to improve rescue opportunities for financially distressed companies through a new set of tools and could be an effective addition to the country's already well-established and well-tested legislative framework.
The Insolvency Service and Kelly Tolhurst, a member of the U.K. Parliament, said in a joint statement that the reforms would "help the Government tackle reckless directors and improve corporate governance to protect creditors, employees and other stakeholders in companies approaching insolvency."
The main new measures include:
- A moratorium on creditor action of up to 28 days, with possible extensions, allowing viable companies more time to restructure or seek new investment to rescue their business.
- A new restructuring plan procedure that will provide an alternative option for financially distressed companies to restructure their debts.
- Greater accountability for directors.
- Prohibiting suppliers from terminating contracts with insolvent businesses.
The proposals — which bear some resemblance to the U.S. Chapter 11 process — aim to ensure that the U.K. remains one of the best places to invest following increased political concern about the ability of the Insolvency Service to deal with large corporate failures such as Carillion and BHS. Both these cases put the spotlight on issues such as director accountability and the effect of large company insolvencies on smaller suppliers.
Among restructuring practitioners and leveraged finance investors, the U.K.'s positive reputation for implementing restructuring has not crumbled as a result of these cases. High-yield bond and leveraged loan borrowers and their creditors have taken, and are still taking, advantage of the country's current tools such as Schemes of Arrangement, or SoAs, and Company Voluntary Arrangements, or CVAs.
Even some non-U.K.-based companies, such as Noble Group most recently, are migrating to the U.K. by shifting their Centre of Main Interest in order to be allowed to restructure debt under English law, to avoid lengthy insolvency proceedings in other jurisdictions.
In a client alert, law firm Freshfields Bruckhaus Deringer said the restructuring plan is modeled broadly on the U.K.'s current scheme of arrangement.
"This is the most groundbreaking of measures and would introduce a seismic change to the insolvency and restructuring toolbox," according to Richard Tett, head of Freshfields Bruckhaus Deringer's restructuring and insolvency team in London.
The proposals also include a new stand-alone procedure whereby a company can propose a restructuring plan to its creditors. Solvent and insolvent companies will be able to use the process, wrote Jonathan Lawrence, restructuring and insolvency partner at law firm K&L Gates, in a client briefing. "The courts will be heavily involved in examining and approving a proposal. It is for the company to propose plans it thinks will be acceptable to creditors. Creditors and shareholders can submit counter-proposals."
As with current SoAs, a restructuring plan must meet a 75% voting threshold, measured by value, for each class. Moreover, the test is supplemented by the additional provision that more than half of the total value of so-called unconnected creditors must vote in support.
This system is loosely modeled on the test currently applicable to CVAs, according to Freshfields. However, it is not clear exactly how unconnected creditors are defined and why they should vote in support, while the current rules under the CVA differ.
"The actual test for a CVA in the Insolvency Rules is a bit different and requires more than half of the total value of unconnected creditors voting against it to be invalid," said Freshfields' senior knowledge lawyer Katharina Crinson.
"So there is some confusion here. 'Connected parties' has a wide definition, and how this applies in a restructuring plan is unclear. For example, is it per class/per affected unconnected creditors, or per total unconnected creditors? Is it the same as the CVA or in the language used in the announcement? Getting it right will clearly make or break the plan as a viable tool."
Meanwhile, cross-class cramdown, where a court imposes a bankruptcy arrangement, will be permitted. Kate Stephenson, partner in the European Restructuring group at Kirkland & Ellis, said in a client alert this is a 'key' addition that draws inspiration from U.S. Chapter 11 proceedings. It includes the ability to bind dissenting classes of creditors who vote against the restructuring plan. "Crucially, the plan may still be confirmed by the court even where one or more classes do not vote in favor, provided at least one class of impaired creditors votes in favor," said Ellis.
A company can also file for a moratorium for 28 days, which may be extended, according to the proposed reforms. Creditors, including secured creditors, would not be able to take action against the company in this period, during which it would be making preparations to restructure. Certain criteria must be met for filing a moratorium, such as that the company is financially distressed but not yet insolvent; has a prospect of rescue; and can demonstrate that it has sufficient funds to carry on its business during the moratorium, meeting current and new obligations as they fall due, Freshfields said.
Company directors — who will remain in control of the business during the moratorium — will also appoint a 'monitor' in the form of a licensed insolvency practitioner, who will assess the qualification criteria. "The monitor will not be able to take an administration or liquidation appointment with the company for 12 months, but can act as the nominee or supervisor of a subsequent company voluntary arrangement," said K&L Gates' Lawrence. Creditors may apply to court to challenge the moratorium if the qualification conditions are not met or if they can demonstrate that they suffer unfair prejudice, Freshfields said.
The moratorium includes a number of new creditor protections, including their right to challenge the moratorium at any time, safeguards derived from the monitor's role, creditor-approved extensions on the moratorium, and new sanctions to deter abuse of the moratorium by dishonest directors, said Kirkland & Ellis' Stephenson.
Greater accountability for directors
The proposals also include new powers for the Insolvency Service to investigate directors of dissolved companies; enhancements to existing antecedent recovery powers; and the ability to disqualify directors of holding companies who unreasonably sell subsidiaries that subsequently become insolvent within 12 months.
Meanwhile, the proposed reforms include the treatment of contractual termination provisions for insolvency reasons. This means suppliers of goods and services and contractual licensors will no longer be allowed to terminate contracts solely on the grounds that the other party has entered a formal insolvency process, a pre-insolvency moratorium process, or the new restructuring procedure.
"However, this prohibition will not prevent termination for reasons of non-payment or other termination provisions upon notice or under fixed-term contracts," Lawrence said. In addition, "a supplier can apply to court to be exempted from this prohibition if it can establish a significant adverse effect on its own business as a result of having to continue to supply."
While extensive drafting of the legislation will now take place, some questions around timing and content remain. Negotiations around Britain's exit from the European Union may slow the implementation of the reforms, while Freshfields also asks: "Will we see companies strategically deciding when to file for the moratorium avoiding a large payment, such as interest on loans, on the day of filing? And how will directors of holding companies balance the existing duty to act in the best interest of that company with the new duty to also act in the interest of the subsidiary's stakeholders?"
Lawyers say it is also unclear to what extent non-U.K. companies can take advantage of the new tools, and if U.K.-sanctioned plans may receive cross-border recognition.
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