COVID-19: Insolvency law proposals for mitigating the short-term effects on viable businesses

There have been increasing concerns in recent weeks that UK insolvency law does not accommodate the short-term impact of COVID-19 on many businesses. In response, the Business Secretary announced on 28 March that the UK's insolvency rules would be amended as part of the Government's wider business support package. Whilst the measures that the Government intends to implement have not yet been fully detailed, this note summarises what has been announced so far and what we might expect, based on the Business Secretary's comments.

Suspension of wrongful trading

The Government has announced a temporary suspension of wrongful trading rules for company directors to remove the threat of personal liability, applying retrospectively from 1 March 2020. It is not clear yet whether there will be any criteria in order to benefit from the suspension of wrongful trading.

This measure would temporarily suspend the provisions of the Insolvency Act 1986, under which directors must, if they consider a company has no reasonable prospect of avoiding insolvent liquidation or administration, take every step to minimise loss to creditors. This very high standard is difficult to meet in the current climate and, without this suspension, if directors decide to continue to trade when there is no such reasonable prospect, they currently face personal liability for the net deficiency caused to the company's creditors from the point where they should have realised that there was no reasonable prospect.

Importantly, the Government noted that all other "checks and balances that help to ensure directors fulfil their duties properly will remain in force". In particular:

there will be no change to directors' duties more broadly, including the duty under s172(3) of the Companies Act to act in the interests of creditors when a company is insolvent;
fraudulent trading rules under the Insolvency Act are not suspended; and
the director disqualification regime will continue to apply.

Directors should continue to be mindful of, and take advice on, their duties in the current circumstances in order to avoid potential liability for breach of duty or misfeasance.

Continuity of supply

The Business Secretary also announced new rules to ensure that companies undergoing a restructuring can secure ongoing supply of essentials such as energy, raw materials and broadband. It is unclear at this point whether this will involve a moratorium or a prohibition on invoking termination for insolvency (i.e. ipso facto clauses – see further below).

Other changes

The Government has also indicated that it intends to bring in new legislation to implement changes to corporate insolvency that it had previously consulted on in 2018. Whilst details of what these reforms would look like in the current environment are scant at this point, we set out below a summary of the changes that were announced in 2018.

A new all company moratorium

The proposals included a new standalone moratorium preventing creditor enforcement action being taken against a company while it considers options for rescue. This moratorium was intended to last for an initial 28-day period, with the potential for the period to be increased by a further 28-day period (plus additional extensions if creditors consent). A "monitor" (a licensed insolvency practitioner) would support the integratory of the moratorium process and ensure that creditor interests are protected, but control of the company would remain with the directors.

These original proposals may also be adapted to lengthen the moratorium period or to relax the eligibility criteria.

Flexible restructuring plan

Another proposal was a new restructuring plan, intended to fill the gap between CVAs (which cannot bind secured creditors) and schemes of arrangements (which lack a cross-class cram down mechanism). This would be a court-approved process which would allow a company to propose a restructuring plan to creditors which, if approved, would bind all classes of creditors even if a particular class votes against the plan. This could be used alongside the moratorium described above.

Prohibiting termination for insolvency (i.e. ipso facto clauses)

As mentioned above, another proposal which may be implemented is the introduction on a prohibition on suppliers using termination rights in their contracts on the basis of a counterparty's insolvency. It is not clear whether such rights would be removed wholesale for a period, or whether a company would benefit from these measures based on COVID-19 related criteria.

HMRC as a creditor in insolvency proceedings

HMRC has published guidance confirming it will pause its use of bankruptcy and winding-up petitions as an enforcement mechanism until 1 July 2020 (unless HMRC deem such insolvency activity to be essential because it relates to fraud or criminal activity). HMRC has also confirmed it will relax its approach to defaults under existing voluntary arrangements. For debtors affected by COVID-19, HMRC will allow contributions due under the voluntary arrangement to be paused for a minimum of three months. Furthermore, if a company takes advantage of the ability to defer VAT payments, this will not be treated as a breach of the voluntary arrangement.

Watch this space

STOP PRESS: The Corporate Insolvency and Governance Bill 2019-21, which will implement these measures, was given its first reading on 20 May 2020. The Bill (available here, with explanatory notes here) appears to contain the features we were expecting, but we will be providing an update shortly.

Read Edward Smith Profile