This article explores the efficacy of the relatively new moratorium procedure introduced under the Corporate Insolvency and Governance Act 2020 and whether the existing domestic legislation already housed a more effective debtor-in-possession rehabilitative procedure in the form of the “light-touch” administration and if so, why it has thus far been largely overlooked.
KEY POINTS
- Moratoria undoubtedly play an important role in company/business rescue. However, management may be disincentivised from making use of moratoria at an early stage of distress if their use is conditional on ceding control to an insolvency practitioner.
- Processes enabling debtors to benefit from a moratorium whilst allowing management to remain in control might encourage them to seek advice at an earlier stage of the debtor's distress and ultimately, preserve value.
- This article considers whether:
- (i) the standalone moratorium introduced by the Corporate Insolvency and Governance Act 2020 achieves this objective or whether the legislature's concern to protect the rights of creditors has weakened its efficacy; and
- (ii) “light-touch” administration provides a more effective “debtor-in-possession” rehabilitative procedure.
INTRODUCTION
Over the last few years, there has been a renewed focus on moratoria in the restructuring and insolvency field both domestically and in Europe, coupled with a shift away from creditor-led processes towards debtor-in-possession regimes that enable the management of a debtor to remain in possession and control of its assets and business operations. This shift has resulted in significant reforms to English and European legislation. Whilst there is a consensus that moratoria and debtor-in-possession features in restructuring regimes can be instrumental in preserving value in viable but distressed businesses, the legislature has had to be mindful to ensure that these features do not interfere with the rights of individual creditors to such an extent that they would damage the confidence of the credit industry and the functioning of credit markets or increase what is often called “moral hazard” (or “bad behaviour”) by debtor management. This article explores the efficacy of the relatively new moratorium procedure introduced under the Corporate Insolvency and Governance Act 2020 (CIGA) and whether the existing domestic legislation already housed a more effective debtor-in-possession rehabilitative procedure in the form of the “light-touch” administration and if so, why it has thus far been largely overlooked.
A HISTORY OF MORATORIA
England was traditionally a secured creditor friendly jurisdiction, especially during the late Victorian period with the development of the floating charge and the power of a secured creditor, usually a bank, to appoint a receiver or manager to the business and assets of a corporate debtor. On the one side the position of the secured creditor has slowly been eroded, for example with the increasing difficulties around securing a fixed charge on book debts and constraints on appointing an administrative receiver and on the other, debtors have increasingly benefited from moratoria, cross-class cram down (through the restructuring plan introduced by CIGA (RP)) and the potential for “light touch” administrations. The reality is more complex with a reluctance to deny secured creditors the substance of their bargaining position, which means that sometimes innovations such as the new moratorium procedure (as discussed below) feel, depending on one's perspective, more like “two steps forward and one step backwards”.
Since the late twentieth century, moratoria have existed in common law, statute, agreed codes of conduct and in other guises. A moratorium provides a financially distressed debtor with a “breathing space”, preventing its assets from being appropriated by creditors enforcing their rights, individually or collectively, in the run-up to a consensual solution or restructuring, which could hamper the debtor's ability to carry on its business and reduce its value as a going concern, particularly where the creditor's objectives or interests conflict with those of the general body of creditors. In the late 1970s, the London corporate banking market developed an approach to company workouts known as the “London Approach”, the main tenets of which included that banks, on hearing that a company to which they had exposure was in financial difficulty, would remain for the time being supportive, keep their facilities in place and not rush to appoint receivers.1 This approach provided the foundation for the guidance and best practice developed by INSOL International for out-of-court workout negotiations between a debtor business and multiple creditors, which include the principle that when a business is in financial difficulties, its creditors “standstill” for sufficient time for proposals for resolving the business' financial difficulties to be formulated and assessed.
The Insolvency Act 2000 gave the moratorium statutory force. It introduced provision (now revoked) for companies in financial difficulties to access an optional moratorium in conjunction with the company voluntary arrangement procedure (CVA) available under the Insolvency Act 1986 (IA 1986) although this moratorium could only be accessed by small and medium sized companies and was criticised for being “burdensome in nature for the insolvency practitioner acting as nominee … bureaucratic and carrying a risk of personal liability”.2 Just over a decade later, Bluecrest Mercantile BV v Vietnam Shipbuilding Group3 established that the court has jurisdiction to order a stay of proceedings under its case management powers, which can be exercised in “special circumstances” (in this case to grant a stay on proceedings pending the implementation of a scheme of arrangement). Lest this was thought to be a one-off, Virgin Active4 successfully applied for and obtained a “Bluecrest” stay in 2021 in connection with a proposed RP. Schemes of arrangement have also been used to effect moratoria or standstills on creditors before a more substantive restructuring can be implemented using a further scheme, as was the case in relation to DTEK Finance plc which, in 2016, applied to the court to implement a standstill in relation to certain notes by way of a scheme of arrangement.
Over the last few years there has been a renewed focus in Europe on moratoria and their role in preserving the value of a company in distress, coupled with a shift away from creditor-led processes towards debtor-in-possession insolvency regimes inspired by the Chapter 11 procedure under the United States Bankruptcy Code 1978. The commencement of a Chapter 11 procedure triggers an “automatic stay”, which is effective against any enforcement action against the debtor or property of the debtor's estate, or the start or continuation of other legal proceedings against the debtor or its property, without the need for the debtor to apply to the bankruptcy court for a moratorium. The automatic stay, coupled with the ability for management to remain in control of a company during the pendency of bankruptcy proceedings, may encourage management to seek advice at an earlier stage of distress, which can contribute to preserving value and goodwill and increase the prospects that the company can be successfully rehabilitated or reorganised. Although neither schemes of arrangement nor the RP benefit from a moratorium, both are debtor-in-possession processes that are generally well perceived in the restructuring community as effective tools for achieving a financial restructuring. Indeed, the scheme of arrangement has been used as a restructuring tool by English and overseas companies alike with increasing prevalence since the Great Financial Crisis and the majority of insolvency practitioners surveyed as part of the UK Insolvency Service's Post Implementation Review of CIGA (PIR) agreed that RPs enable companies with viable businesses that are struggling to meet debt obligations, to restructure with limited disruption to their operations.5
The EU Directive on Restructuring and Insolvency of 20 June 20196 (EU Restructuring Directive) required EU member states to offer a “preventive restructuring framework” for companies in a financially distressed situation when there is a likelihood of insolvency, which should include a stay of individual enforcement of actions to facilitate negotiations on preventative restructuring plans.7 This shift in the collective consciousness perhaps recognises that existing management may be reluctant to file for a procedure that requires them to cede control of the company to an insolvency officeholder until it is “too late” to effect a rescue of the company, they may be best placed to steer a company away from difficulty and that it is not always the actions of management that have led to its demise.
CIGA introduced certain temporary measures to support businesses during the COVID-19 pandemic that constituted a form of moratoria on creditor action, including restrictions on presenting winding-up petitions. Additionally, CIGA introduced a new standalone moratorium8 (New Moratorium) which allows the management of a debtor that is or is likely to become insolvent to pursue a rescue or RP under the protection of a moratorium of, initially, 20 business days. Unlike the moratorium that applies during administration, existing management can continue to manage the business and seek to navigate out of financial difficulty under the protective shield of the moratorium, subject to the monitor “monitoring” the company's affairs. During the New Moratorium, restrictions apply to the commencement of insolvency proceedings (except where commenced by the directors), the enforcement of security, including on the holder of a qualifying floating charge (QFC) appointing an administrator under para 14 of Sch B1 of the Insolvency Act 1986 (IA 1986) and on the commencement or continuation of legal process. Certain debts that have fallen due before the commencement of the New Moratorium (or become due during the New Moratorium because of an obligation incurred before the New Moratorium) are subject to a “payment holiday”.
The New Moratorium ought to provide management with an attractive, efficient, cost-effective tool to support the return of a company to profitability. Indeed, according to the Department for Business, Energy & Industrial Strategy (as it then was), the aim of the New Moratorium was to provide struggling companies with: “a streamlined moratorium procedure that keeps administrative burdens to a minimum, makes the process as quick as possible and does not add disproportionate costs on to struggling businesses”.9 Yet according to Insolvency Service statistics, a mere 45 New Moratoria were obtained between 26 June 2020 and 30 June 2023.10
The limited take-up of the New Moratorium could be, in part, explained by the fact that many types of company including certain types of insurance companies and payment institutions are ineligible for the New Moratorium.11 Further, the New Moratorium does not apply to financial services contracts and instruments, which means that a debtor will need the support of its financial creditors to commence or continue a New Moratorium (financial creditors are not able to enforce security during the moratorium except in relation to financial collateral arrangements but may accelerate their loans, following which the monitor will most likely terminate the moratorium). There are also a number of carve-outs from the scope of the New Moratorium that may erode its efficacy from the perspective of a debtor. For example, certain debts do not benefit from the “payment holiday”, including goods or services supplied during the moratorium, rent in respect of a period during the moratorium and wages and salaries.12
The second reason for the limited take-up of the New Moratorium could be that insolvency practitioners are reluctant to take roles as monitors. This reluctance could stem from the following factors:
- the potential scope for liability and uncertainty as to the precise scope of the role of a monitor. For a company to obtain a New Moratorium, the proposed monitor is required to file a statement at court that, in their view, it is “likely” that a moratorium for the company “would” result in the rescue of the company as a going concern (whereas an administrator is only required to state that the purpose of administration is “reasonably likely” to be achieved).13 The implication is that a monitor will need to have a high degree of confidence that a rescue of the company as a going concern can be achieved, which in some cases may require substantive engagement with management and preparatory work in the pre-appointment period (and therefore cost to the company). The Insolvency Service have provided some guidance as to how much due diligence insolvency practitioners need undertake in order to feel comfortable in making such a statement, but it is unlikely to completely dispel their concerns.14 With regards to the scope of the role of a monitor, it is not clear the extent to which the monitor's involvement in creditor negotiations and stakeholder management, board meetings and/or formulating a rescue plan is necessary for the monitor to adequately discharge its obligations;15
- concerns about the reputational risk of acting as a monitor in cases where a company rescue is not achieved as well as about the change in priority for their fees in a subsequent insolvency, points which were noted in the PIR;16 and
- concerns that the moratorium may be abused or misused to achieve a reprieve from its creditors by unscrupulous directors, or directors of companies that are not viable. Indeed, many of the respondents to the Insolvency and Corporate Governance consultation17 (Government Consultation) who did not support the introduction of a moratorium were creditor groups or representatives who had concerns that the moratorium would be abused, including by businesses that had no realistic prospect of rescue.
These factors may prove to be barriers to insolvency practitioners pushing appointments through their risk committees or lead to insolvency practitioners recommending administration proceedings instead of the moratorium.
Third, the duration of the New Moratorium is unlikely to be sufficient to agree a proposal for the rescue of the company as a going concern, save in respect of SMEs or companies with relatively straightforward financial arrangements. The directors of a company may extend the New Moratorium once for a further 20 business days, or for up to one year with creditor consent or by order of the court. However, these processes can be bureaucratic and costly. The Government Consultation suggested that the moratorium would initially last for up to three months. This period is closer to that set out in the EU Restructuring Directive, which provides that a stay of individual enforcement actions should apply for a maximum period of up to four months but recognised that complex restructurings may require more time.18
“LIGHT TOUCH” ADMINISTRATIONS
Given the issues relating to the New Moratorium described above, why has the “light-touch” administration, which is a form of “debtor-in-possession” process that benefits from a far-reaching moratorium, been largely overlooked?
Administration is, at its heart, a rescue procedure. The rescue of the company as a going concern is the first purpose of administration19 and only if the administrator is of the opinion that this is not reasonably practicable or that a better result can be achieved for the company's creditors by some other course is he permitted to disregard that primary objective. However, the rescue of the company as a going concern is rarely achieved through an administration. Directors can be reluctant to file for administration, at least until value has been materially eroded, given that it is traditionally a “management-displacing” procedure. Additionally, subject to a number of exceptions or safe harbours for certain markets, administration has become the common pathway for insolvency proceedings rather than being a rehabilitative procedure and is typically perceived as a measure of “last resort”. Administration was given a boost by the Enterprise Act 2002 and as another tentative step towards the rescue culture reduced the scope for the appointment by secured creditors of administrative receivers under s 72 of the IA 1986 and instead provided those secured creditors with QFCs the ability to appoint an administrator.20 However, the holder of a QFC still wields considerable power to make an administration appointment since it can do so without recourse to the court and without having to demonstrate that the company is or is likely to become unable to pay its debts as they fall due.
Yet a “light touch” administration may be more palatable for management, particularly where they consider that the circumstances leading up to the insolvency of the company were outside their control. This term describes an administration in which the administrators have made use of the powers in para 64(1) of Sch B1 to IA 1986 to authorise directors to continue to exercise management powers21 akin to a debtor-in-possession process. The viability of this approach is, of course, predicated on the assumption that the administrators have a degree of confidence in existing management and that the actions of management are not the root cause of the demise of the company.
In these circumstances, the “light touch” approach provides a useful tool to leverage the expertise of existing management to help a company navigate through a period of difficulty under the protection of the statutory moratorium.
The COVID-19 pandemic created the circumstances in which the “light touch” approach to administration could be deployed; namely, that the circumstances causing the financial distress of a company were primarily caused by external factors, rather than the performance of management. This approach was employed in Re Debenhams,22 in which the administrators' proposals included consenting to the exercise of certain operational powers by the current management and working with them to stabilise the business during the COVID-19-related uncertainty. There are other examples of the use of “light-touch” administration, but even so, there has been limited deployment.
Administrators will naturally be cautious about authorising management to exercise management powers, given the potential for opportunistic practices and that the responsibility for the conduct of the administration falls squarely with the insolvency officeholders23 – it was reported that KPMG declined to act as the administrators of Debenhams because of the perceived risks24 – and the ICAEW have cautioned its member insolvency practitioners against “the widespread use of this process” noting that: “responsibility for the conduct of any insolvency appointment falls to the officeholder and there is a significant potential risk to an IP if they commit to agreements that allow the directors to enter into transactions on their behalf”.25
The draft “Consent protocol” (Protocol) drafted by the Insolvency Lawyers Association and City of London Law Society in partnership with South Square26 may go some way to alleviate administrators' concerns. The Protocol is a template protocol designed to support a light touch administration process where the objective of the administration is to rescue the company as a going concern and can be adapted to the particular circumstances and the business of the company. The Protocol specifies the powers that management are authorised to exercise during the course of the administration and the terms and conditions on which the administrators have consented to management exercising such powers and includes safeguards around the exercise of those powers. For example, the Protocol envisages that management's powers to acquire stock-in trade, pay salaries due under pre-administration contracts to any employees, contractors or agents and incur credit with suppliers and other counterparties are subject to monetary limits. The Protocol also requires that management prepare management accounts periodically showing a true and fair view of the financial position of the company and inform the administrators of any fact or other information which could suggest to a reasonable person that there is no longer any reasonable prospect of achieving the rescue of the company as a going concern.
Arguably, the nature of the mechanism in para 64(1) of the IA 1986, which requires a considered, deliberate devolution of management powers from the administrator to the directors coupled with the framework provided through the Protocol, which provides safeguards around the exercise of these powers, provides a better starting point from the perspective of insolvency practitioners concerned about potential liability than the New Moratorium, where the directors remain at the helm of a distressed company and the insolvency practitioners have responsibilities of uncertain scope. However, for the reasons noted above, the use of the “light-touch” administration is in practice limited to situations in which the administrators (and, depending on the circumstances, other stakeholders) have a degree of confidence in the management of a debtor; administrators are unlikely to take the risk of potential liability without this.
The concerns of administrators and monitors, in particular with regards to the potential scope for liability would fall away if a process analogous to the Chapter 11 process were enacted, whereby the court is heavily involved throughout the proceedings. However, with greater court involvement comes the potential for greater cost and time to agree a workout or restructuring.27 One of the key benefits of the “light-touch administration” procedure is that it is intended to save costs and as noted above, the New Moratorium is intended to avoid adding disproportionate costs on to struggling business. Further, the English judicial system is unlikely to have sufficient resource to provide the degree of oversight provided by the US courts in a Chapter 11 process. In any event, increasingly the trend in the United States is for a debtor to try to reach agreement with key stakeholders regarding the proposed outcome of the Chapter 11 case before the Chapter 11 filing is made; Chapter 11 is then used as the means of implementing the agreement. This mechanism, known as a “pre-packaged bankruptcy”, allows the debtor to take advantage of the benefits of Chapter 11 (for example, the ability to consolidate claims in the bankruptcy court and “cram-down” dissenting creditors) and gives the debtor comfort that the requisite support for the plan will be likely achieved before a filing is made. This can significantly reduce the time a debtor spends in the Chapter 11 process (in some cases to fewer than 90 days compared to a matter of months or years as can be typical for complex Chapter 11 proceedings), thereby reducing costs, uncertainty and disruption to the debtor's business. Whilst the “pre-pack” process is neither without criticism nor appropriate for every situation, this trend away from prolonged court involvement perhaps indicates that the preference towards an out-of-court process reflected in English insolvency legislation strikes the right balance.
CONCLUSIONS
There is undoubtedly a continuous shift towards debtor friendly provisions in the English legislation, which is itself reflective of the direction of travel of law reform internationally. It is a hesitant one however, reflecting the need to preserve the confidence of the credit markets already impacted by the difficult macro environment and taking into account the ever-changing nature of the markets. As a consequence, it may be a while before we see a moratorium procedure or indeed another debtor-in-possession procedure which is more widely employed by debtors. Conversely those provisions which facilitate a restructuring such as RPs, where the debtor has the support of one or more material groups or classes of creditors, are seeing wider deployment and greater success.
1 Pat Kent in a speech to the Chartered Institute of Bankers on 12 November 1992.
2 Paragraph 5.10 of the Insolvency and Corporate Governance: Government response, 26 August 2018.
3 [2013] EWHC 1146 (Comm). See also Sea Assets Limited v PT Garuda Indonesia & Ors [2001] WL 1251844.
4 Riverside CREM 3 Ltd v Virgin Active Health Clubs Limited [2021] EWHC 746 (Ch).
5 Paragraph 3.21.
6 EUR 2019/1023.
7 Article 6 of the EU Restructuring Directive.
8 Part A1 IA 1986.
9 https://publications.parliament.uk/pa/bills/cbill/58-01/0128/en/20128en.pdf Para 6
10 Official Statistics. Commentary – Monthly Insolvency Statistics June 2023.
11 Schedule ZA1, IA 1986.
12 A18(3) IA 1986.
13 Schedule B1 IA 1986, para 18 (3)(b).
14 See 'Dear Insolvency Practitioner' Issue 135, August 2021.
15 The Insolvency Service has also published a guidance document for monitors, but it is not exhaustive and does not have legal force https://www.gov.uk/government/publications/insolvency-act-1986-part-a1-moratorium-guidance-for-monitors/test-doc
16 Paragraph 4.10. See also para 4.3.4.2 of the Corporate Insolvency and Governance Act 2020 – Interim report March 2022.
17 https://www.gov.uk/government/consultations/insolvency-and-corporate-governance
18 Preamble (35) and Art 6, para 8.
19 Paragraph 3(1) of Sch B1, IA 1986.
20 Paragraph 1, Sch B1, IA 1986.
21 Re One Blackfriars Ltd [2021] EWHC 684 (Ch), para 271.
23 Paragraph 68 of Sch B1, IA 1986.
24 https://www.ft.com/content/76c7c985-ff8c-4707-b4e4-28eb7a8f7b62
26 Mark Phillips KC, Stephen Robins and William Willson.
27 In the US, certain small business debtors may elect to file for relief under subchapter V of the Bankruptcy Code, which is intended to streamline processes and reduce costs.
Originally published in Journal of International Banking & Financial Law, Volume 38, Issue 11, December 2023.