Arrangements and reconstructions for companies in financial difficulty
June 4, 2020
The Corporate Insolvency and Governance Bill (‘CIGB’) had its second reading on 3 June 2020. Its Clause 7 of and Schedule 9 seek to make provision for a new form of insolvency process by inserting a new Part 26A into the Companies Act 2006 (sections 901A to 901L) and making consequential amendments to other statutes. This commentary is written on the basis that the CIGB will be enacted as it is currently drafted. The Act, if passed, should be reviewed for any differences from the text of the Bill.
Modelled on sections 895 to 901 of the Companies Act 2006 (the existing Part 26), the new provisions extend to financially distressed companies the opportunity to enter into arrangements or reconstructions with their creditors or members.
Moratorium and reconstruction
One of the most far-reaching changes proposed in CIGB is the introduction of the Moratorium. Consulted on in 2016, the Government’s response dated 26 August 2018 included proposals for the Moratorium and a “flexible restructuring plan,” which now appears to be embodied in the new Part 26A of the Companies Act 2006. Both are new insolvency regimes.
It does not appear to be intended that the two regimes are mutually exclusive. Rather, as is said in the Explanatory Note to CIGB (paragraph 7), the Moratorium is not a gateway to a particular insolvency procedure but possible rescue outcomes include the implementation of a restructuring plan under the new Part 26A of the Companies Act 2006.
Company directors, faced with the deterioration of their company’s financial health could seek to obtain a Moratorium and then seek to achieve a reconstruction as the exit route from it, in an attempt to preserve the value in the company’s underlying business.
However, the entry criteria to the two regimes are not entirely consistent, potentially preventing companies who qualify for a reconstruction from obtaining the protection of a Moratorium attempts are made to implement it.
If a Moratorium is obtained, it will prevent (except with the Court’s permission) the enforcement of any security (with limited exceptions) and the repossession of goods in the Company’s possession under a hire-purchase agreement. It will prevent a floating charge from crystallising and will delay the moment at which a floating charge-holder can give notice under it, so as to make it crystallise. (Detailed commentary on the Moratorium provisions is for another time.)
Application of the new provisions
What is intended to be section 901A of the Companies Act 2006 provides for Part 26A to apply where two conditions are met. The second condition itself breaks down into two parts such that there are in reality three conditions which must be satisfied.
The first condition is that the company has encountered, or is likely to encounter, financial difficulties that are affecting, or will or may affect, its ability to carry on business as a going concern.
The second condition is that a compromise or arrangement is proposed between the company and its creditors, or any class of them, or its members, or any class of them.
The third condition is that the purpose of the compromise or arrangement is to eliminate, reduce or prevent, or mitigate the effect of, any of the financial difficulties mentioned in the first condition.
Certain companies are excluded by section 901B. The reconstruction proposed can include an amalgamation or the transfer of the business and assets of one company to another; see section 901J.
It can immediately be seen that “financial difficulty” should have a broad interpretation. That is consistent with the policy background stated in the Explanatory Notes of “ensuring businesses can maximise their chances of survival.” The company does not have to be insolvent or likely to become insolvent, with likely meaning probable (see BAT Industries plc v Sequana SA  EWCA Civ 112 at paragraph 220). The test seems to be much lower; note the use of the words: “… financial difficulties that … will or may affect its ability to carry on business as a going concern.”
The wording of the provision also seem to better fit a commercial solvency analysis rather than a balance sheet view. That would seem appropriate in a situation where enforced cessation of trading has plunged many businesses into cashflow trouble. That said, however, the value of those businesses’ assets may have deteriorated to such an extent they are also insolvent on a balance sheet basis.
The breadth of the meaning of “financial difficulty” is to be welcomed because it opens up to more companies the opportunity of using these provisions but, at the same time, that also increases the scope for argument.
There is the potential for a company in financial difficulty within the meaning of section 901A not to be insolvent or likely to become insolvent, that being one of the threshold tests for obtaining a Moratorium. Such a company would then be at risk pending the reconstruction being sanctioned. Similarly, the proposed monitor must state that, in their view, it is likely that the Moratorium would result in the rescue of the company as a going concern. Depending on the terms of any reconstruction, the company might or might not emerge as a going concern. If it simply proposes to pay its creditors a dividend (in which case it might prefer a CVA; cost considerations will arise) then it could continue to trade as a going concern. But if the scheme is more sophisticated then it might not.
Compromise or arrangement
The wording of section 901A(3)(a) is the same as that in section 895(1). Most likely, what will be proposed is a compromise of what the company owes to its creditors, or a class of them, whether described as a compromise or as an arrangement, the latter label perhaps being most useful where the scheme to be proposed is more complicated than a simply compromise of debts owed.
Eliminating, reducing, preventing or mitigating the effect of the financial difficulties
Again, it is straightaway clear that there is no restriction on the way in which the scheme can help the company in question, as long as what is proposed meets the financial difficulties that have been identified.
In outline, the court is asked to order that a meeting of creditors or members (or a class of either) be summoned at which the company’s proposed reconstruction is considered. If 75% in value of those present and voting approve it, then the Court has a discretion whether to sanction the reconstruction, even where (subject to prescribed conditions) there is dissent.
In a straightforward case, a decision will have to be taken whether to propose a CVA or to jump through the hoops involved in obtaining sanction for a reconstruction. It may well be that the decision which regime to enter is driven (at least in part) by the cost of entry. Where the company’s money is already tight, spending more of it on professional fees than is strictly necessary might be hard for directors to justify. If the process closely echoes that under Part 26, it might be too expensive; the relevant practice direction has not yet been issued.
Section 901C confers a discretion on the Court to order, on an application made under section 901C(1), that a meeting be summoned. It is not only the company that can apply for the Court to do so. By section 901C(2), an application can be made by the company, a creditor, a member, its liquidator if the company is being would up or its administrator if it is in administration.
Every creditor or member whose rights are affected by the scheme proposed must be permitted to participate in a meeting ordered by the Court. But, if there is a class of creditors or of members none of whom have a “genuine economic interest in the company” that class does not have to be permitted to participate in the meeting. An application to exclude an “out of the money” class must be made by the person who initially applied for the order that a meeting be summoned. Further, where an application is made before 12 weeks have gone by since the end of a Moratorium and the creditors include a “Relevant Creditor” (being a creditor in respect of a debt accrued during the Moratorium or in respect of a debt accrued as a result of a pre-Moratorium liability for which there has been no payment holiday) the Relevant Creditor may not participate in the meeting. An attempt to exclude an “out of the money” class is likely to be contentious, at least before any application comes before the Court, but it ought to be straightforward to demonstrate on the evidence whether a class is in the money or out of it. Likewise, it ought to be simple enough to demonstrate whether a creditor is a Relevant Creditor and therefore prohibited from participating in the meeting.
If the Court orders a meeting to be summoned, a statement giving the details prescribed in section 901D must be provided. This is likely to be an area where challenges can arise, where a dissatisfied creditor complains that the statement did not include the requisite detail such that the Court could not go on to exercise its discretion. Directors have a duty under section 901E to provide information to enable the company to make a statement complying with section 901D.
If the Court summons a meeting then the outcome of that meeting will determine whether the Court has discretion to sanction the scheme in question. If the scheme is approved by at least 75% in value of a class who would receive a payment (i.e. those having a genuine economic interest who are therefore “in the money”) then the court may (on the application of the company, a creditor, a member, a liquidator or an administrator) sanction it under section 901F, subject to two points.
First, under section 901G, where one or more classes dissent, the Court may still sanction the scheme if two conditions are met:
(a) if the dissenting class would not be any worse off under the proposed scheme than they would be under a “relevant alternative” (which is likely to be a terminal process such as liquidation or administration); and
(b) if the scheme has been agreed by 75% in value of those creditors who would be in the money in the event that the relevant alternative were to take place.
This cross-class cram down can force the scheme onto dissenting creditors and it is conceivable floating charge-holders might find themselves forced into a scheme, a situation which is likely to be highly contentious.
Second, and to contrary effect, if the scheme includes a Relevant Creditor who has not agreed to the reconstruction, the Court may not sanction it; see section 901H(5). This provision is likely to cause difficulty where there are Relevant Creditors and the reconstruction is proposed within 12 weeks of the end of the Moratorium.
Like the Moratorium, this is a new debtor-in-possession insolvency regime aimed, according to the apparent policy, at facilitating the rescue of viable companies facing temporary cashflow difficulties. Difficulties do arise from the way in which the provisions are drafted, as have been pointed out above. One of the highest potential hurdles is the cost of entry into the regime, not least because two applications are required. There is also the disconnect between the requirements for entry into the Moratorium and the requirements for entry into a reconstruction. Further, the existence of Relevant Creditors is likely to cause difficulties where, as is likely, there is an urgent need to enter into an appropriate insolvency regime after the end of the Moratorium.
CIGB is anticipated to become law very shortly. It remains to be seen how popular reconstructions turn out to be when it is already possible for a company to propose a CVA, which, for many companies, is likely to have much the same practical effect.