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The Insolvency and Corporate Governance Consultation: A Review

The government's response to the recent Insolvency and Corporate Governance Consultation has increased the emphasis on flexibility and the restructure and rescue of businesses. However, along with the recent October Budget, there are proposed reforms which are set to increase the focus and accountability for directors of companies.

Preliminary Moratorium

One of the key new proposals to be introduced with the aim of rescuing companies is a "Preliminary Moratorium".

The procedure is aimed at companies that are struggling financially but are not insolvent. Such companies will be allowed to file for a moratorium on claims - similar to an Administration moratorium - in order to allow time for "breathing space" to turn the company around.                 

The Monitor

Similar to out-of-court Administration appointments, the moratorium will be obtained by filing the necessary documents with the court and appointing a consenting "Monitor". The Monitor must be a licensed insolvency practitioner. Their role will be to notify all creditors of the moratorium, file a notice with the Registrar of Companies, and to ensure that the company's eligibility remains met throughout the course of the moratorium. The monitor will be under a duty to end the moratorium if the company becomes ineligible during the period, and will also need to sanction any asset disposals that are outside the ordinary course of business. Fees will be a contractual arrangement between the monitor and the company and will not be statutory.

Eligibility

The official line on eligibility is that a moratorium will be appropriate if a company will become insolvent "if no action is taken", and that a rescue of the company is "more likely than not". Although this may be difficult to pin down in practice, the proposed Monitor will be responsible for determining whether a company meets this criteria.

The Preliminary Moratorium will not be available for a company that has been in Administration, a CVA or another Preliminary Moratorium in the preceding 12 months .If a company becomes "unable to pay its debts as they fall due" during the period of the Preliminary Moratorium, the Monitor must terminate the moratorium and, if necessary, put the company into an alternative insolvency process.

Duration

The initial moratorium period will be 28 days. The company may then apply to the Monitor for a further 28 day moratorium at the end of this period, but creditors must be notified. Any further extensions will need to be justified on the grounds that there are reasonable prospects of an extension leading to the company's turnaround, and will either need to be approved by the Court or require the approval of 50% of both secured and unsecured creditors. Creditors may also challenge the moratorium at any time during the period if they believe the eligibility criteria are not being met.  

Costs

The costs incurred during the Preliminary Moratorium will be payable by the company and treated as an expense. If the company subsequently enters Administration or Liquidation, then the costs of the Preliminary Moratorium will obtain a super priority over other expenses. It is also worth noting that a Preliminary Moratorium will not exempt directors from a later claim for wrongful trading and/or misfeasance.

The change will offer exciting new opportunities for Insolvency Practitioners. Although there are bound to be teething problems, it is a welcome development and it is encouraging to see such commitment to promoting the turnaround and rescue culture.

New Insolvency Process - Cross-class cram down

The government also plans to introduce a new insolvency process, similar to Chapter 11 proceedings used in the USA. The process will be available to both solvent and insolvent businesses and will be proposed by either the company or an Insolvency Practitioner. The process will be an in-court process.

Once approved, the plan would bind all creditors, secured and unsecured, regardless of whether they vote in favour, against or abstain, known as a “cram down”. This will ensure that dissenting creditors, or creditors not due to receive a dividend will be bound by plans which will be in the best interests of all creditors as a whole. Dissenting classes of creditors must be paid in full before more junior classes of creditors. The voting threshold will be 75% by value and at least one class of impaired creditor must also vote in favour of the plan.

This process will be separate to the new moratorium and existing schemes of arrangement.

Enhanced Accountability for Directors

Following the recent Insolvency and Corporate Governance Consultation, the government has responded with various proposals to increase accountability of directors.

Directors of dissolved companies

The government intends to amend the Company Director Disqualification Act 1986 (CDDA) to extend to former directors of dissolved companies. This will mean that directors who have dissolved companies, rather than entering formal insolvency proceedings, will still be investigated and, if appropriate, face disqualification proceedings.

Preference Payments

The presumption of insolvency when a transaction is to a connected party will be extended to include preference payments under s239 Insolvency Act 1986. This will mean that, provided the transaction was to a connected party within the relevant time, both desire to prefer and insolvency will be presumed and the burden shifts to the recipient of the preference payment to rebut the presumptions.

Illegal Dividends

Dividend payments regimes are currently under review and are likely to come under much more scrutiny. The government is considering the introduction of legislation to ensure that companies will have to disclose figures for available reserves and profits in annual accounts. They are also considering tightening the definition of "net assets" and changing the way goodwill is valued.

Sale of Subsidiaries

Where directors of a holding company do not give reasonable consideration to the interests of stakeholders of a subsidiary when it is sold and that subsidiary subsequently enters insolvent liquidation or administration within 12 months of the sale, the directors may be subject to disqualification proceedings. The government proposes to produce legislation to provide guidance on whether the actions of the directors were reasonable.

Sentencing Guidelines - Offence of acting as a director whilst disqualified

The Sentencing Council introduced guidelines for sentencing directors who act in breach of a director's disqualification order, which came into force on 1 October 2018. The guidelines set out the factors the court must consider when passing sentence and the maximum penalty is 2 years imprisonment. Further details can be found here.

Prescribed Part

The prescribed part cap is expected to increase from £600,000 to £800,000. This will mean that unsecured creditors will benefit from increased pay outs in cases which reach the cap limit.

Suppliers Terminating Contracts

Many supply contracts and licences contain clauses which provide that the contact will be terminated if the company enters into an insolvency procedure. Under the new proposals, these clauses will no longer be enforceable unless the supplier makes an application to the Court. Of course, a company in Administration or similar will not be exempt from other breaches of contract - but it is welcome news for Insolvency Practitioners, particularly those managing trading Administrations.

HMRC Changes

The budget of October 2018 contained two important changes regarding how HMRC will be dealt with in insolvency processes.

Preferential Creditor

From 6 April 2020, HMRC will gain preferential status on all taxes collected by a company and held on behalf of other taxpayers, such as VAT, PAYE, income tax and employee NIC. The preferential status will not apply to tax owed by the company itself, such as corporation tax.

The change will be disappointing news for unsecured creditors, as the amount available to them as a class will surely diminish substantially. However, with potentially greater recoveries available, HMRC are likely to become more engaged and more willing to fund litigation.

Tax Avoidance Schemes

In the proposed Finance Bill of 2019 - 2020, if there is a risk of a company entering insolvency then directors involved in tax avoidance or tax evasion will be made jointly and severally liable for the company's tax liabilities. For IPs, this will present a new avenue of recoveries against company directors, and we are again likely to see further close involvement with HMRC in the running of litigations.

Conclusion

The proposed reforms appear to be a balance of positive changes, introducing more rescue options for businesses, whilst increasing the focus on director accountability. The reforms are likely to provide new opportunities for Insolvency Practitioners whilst directors are set to face further scrutiny and investigations.

For any more information on the topics within this article please contact Connor Pierce on c.pierce@ashfords.co.uk or Cathryn Butler on c.butler@ashfords.co.uk from the Restructuring and Insolvency Team. 

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