The 2020 Act: the landscape for lenders
06 August 2020
The Corporate Insolvency and Governance Act 2020 makes both temporary and permanent changes to UK insolvency laws. As part of these changes, a new ‘debtor-in-possession moratorium’ has been introduced enabling companies to have breathing space from creditor pressure and time to reorganise or restructure their liabilities.
However, unlike an administration a company can obtain a moratorium without first notifying any qualifying floating charge holders (QFCH). The directors retain control of the company and largely trading continues as ‘usual’, albeit with some restrictions. For a QFCH the new process could mean, at least in theory, that they learn about their customer’s insolvency after the company has filed for protection.
While the moratorium will benefit companies in distress, what does this mean for the lending market? This article explores the impact on secured lenders, focusing in particular on the impact on a QFCH. It also provides some comments and thoughts on how a lender can seek to address that impact.
(Lack of) control over the process
Unlike an administration, the mechanics of the moratorium give lenders limited input and control over the process.
Firstly, the directors are not required to give notice to a QFCH of their intention to file for a moratorium and therefore there is no option for a QFCH to appoint an insolvency practitioner (as there would be in an administration) of their choosing.
Secondly, a QFCH is unlikely to have any say in whether the moratorium is extended beyond the initial 20-business-day period. The moratorium can be extended for up to 12 months with creditor (or court) consent. However, the required creditor consent for these purposes is from creditors whose debts fall outside of the moratorium ie those debts from which the company benefits from a payment holiday. Debts arising from loan agreements and other finance documents do not fall into that category and have to be paid during the moratorium.
As such, lenders are unlikely to form part of the voting class of creditors, and would not be able to vote down any requests for an extension.
Will lenders still get paid?
A company subject to a moratorium is given breathing space from ‘pre-moratorium debts’ that have fallen due from which the company has a ‘payment holiday’ (whether due before or during the moratorium). This catches, among other things, trade creditors.
However, there are certain debts that the company must pay during the moratorium and failure to do so may cause the monitor to terminate the moratorium (and/or prevent the directors from seeking an extension of the moratorium). This includes debts and other liabilities arising under a contract or other instrument involving financial services. This means that the usual capital and interest payments due to lenders will still be payable (unless otherwise agreed with the lender).
Although lenders’ debts will still need to be paid during the moratorium, the restrictions may significantly impact the enforcement options available to lenders. Lenders may well wish to factor the following in to their credit and operational procedures to enable them to deal with the risk of a hostile monitor appointment by the company’s directors:
- The moratorium suspends a QFCH’s ability to crystallise its charge or appoint an administrator.
- Certain floating charge provisions enhancing a QFCH’s rights may be void (eg provisions providing for crystallisation of a floating charge – whether automatic or following notice, and restrictions on the disposal of property).
- Under the moratorium, charge holders are unable to enforce security without court consent.
Other security risks
Floating charge assets
A company can either (a) deal with assets in accordance with the terms of the floating charge instrument; or (b) obtain consent of the court to deal with the assets in another way.
As the floating charge cannot be crystallised, and floating charge assets can usually be disposed of in the ordinary course of business (which the moratorium allows the directors to do) this potentially materially depletes the assets available to a lender ahead of any post-moratorium enforcement.
If floating charge assets are sold, lenders will have a floating charge over the proceeds of sale, but usually will not be directly entitled to the proceeds (and cannot enforce the charge to obtain payment).
Lenders should therefore review the terms of their security and facility to consider whether the restrictions and controls provide adequate protection, in particular how and when companies can dispose of assets and fine tuning the definition of a disposal of assets in the ‘ordinary course of business’ (eg whether consent should be required for a bulk stock sale).
While such controls are not ordinarily as important, the inability to crystallise a floating charge or otherwise enforce security during a moratorium, may mean that restrictions need to be tighter to retain some control and dialogue with companies in the event of a moratorium (while still enabling the company to trade effectively).
Fixed charge assets
A company cannot dispose of property subject to fixed charge security without court consent. However, directors may apply to the court to dispose of property as if it were not subject to the fixed charge.
If fixed charge security is disposed of, the Act requires that fixed charge holders receive compensation for their loss of rights (effectively reimbursing the lender for what the court thinks the property would be worth in the open market).
However for the charge holder this effectively enables a restructuring package to ignore the security and could result in fixed charge holders being put at a significant disadvantage, with a loss of rights and value (particularly in a potentially depressed market).
Lenders should also be comfortable that fixed charge security will withstand scrutiny and is not vulnerable to challenge as a floating charge. The risk of fixed charge assets being treated as floating charge assets could be substantial, as the assets could be sold without court consent and the proceeds of sale (and other compensation) would not be required to be paid to the lender.
Lenders should consider auditing their charges to ensure that appropriate levels of control are exerted over fixed charge assets. For example, if taking a charge over plant and machinery, ensuring it is properly scheduled to the debenture, there are restrictions on disposal and valuable items are plated.
Similarly, if a lender intends to create a fixed charge over debts (as opposed to an assignment), they will need to ensure that the receipts are paid into a blocked account and other appropriate controls are both in place, and enforced.
What options or protections are there for lenders?
Appointing an insolvency practitioner
Although a QFCH cannot appoint an administrator during the moratorium, the moratorium will automatically terminate upon directors filing a notice of intention to appoint administrators. At that point, the QFCH would be able to exercise its powers as usual and regain control of the appointment process by appointing its own nominated insolvency practitioner as administrator, if it was not comfortable with the directors’ choice.
Bank debt is not subject to a payment holiday and therefore must be paid during the period of the moratorium. Further the directors will not be able to extend the moratorium if it is not paid.
Lenders may take some comfort from the fact that (a) they should be paid; and (b) the moratorium must be immediately terminated by the monitor if the company does not pay or if the monitor forms the view that it is no longer likely that the company can be rescued as a going concern.
Entering into a moratorium, will in many cases constitute an event of default under facility and security documents that will automatically accelerate the entire debt. Even in those cases where acceleration is not automatic, it may be open to lenders to issue a notice accelerating their debt to make it payable on demand during the moratorium period and thus regain some control given the company is unlikely to be able to pay.
If the entire debt is accelerated it becomes due and payable during the moratorium period. If it is not paid the monitor must terminate the moratorium. This gives lenders the ability to bring the moratorium to an end or improve their negotiating position. That said, the government was keen to make it clear that they expected lenders to support the moratorium and given there is power in the Act to make immediate changes to close any loop holes it is likely that the ability to accelerate could be changed.
In addition, the following options seem to remain open to lenders:
- The Act introduces ipso facto provisions preventing termination of contracts upon insolvency. However, financial services providers are generally exempt from these restrictions. Therefore lenders could cancel non-committed facilities (eg overdraft and invoice discounting) and may also be able to rely on provisions in the facilities to, for example, charge default interest, carry out additional audits or impose an independent bank review (which would be payable as moratorium expenses).
- Lenders may be able to obtain additional security for additional lending (subject to obtaining the monitor’s consent).
- Lenders can challenge the conduct of the directors or the monitor at court, which may result in the reversal of detrimental decisions.
How will lenders’ debts be ranked in a subsequent insolvency?
Where a company enters into administration or liquidation within 12 weeks of the moratorium ending the Act introduces a new order of priority to deal with moratorium and pre-moratorium debts that should have been paid during the moratorium (ie bank debt).
This ‘super-priority’ means that if there is a subsequent liquidation or administration those unpaid debts will rank ahead of preferential creditors, the usual administration/liquidation expenses and floating charge distributions. However, lenders’ debt will rank behind suppliers who are covered by the ‘ipso facto’ provisions and employment-related costs. This would appear to be a significant disincentive for secured lenders to continue to support the company and provide working capital funding during the moratorium.
Also, the ‘super priority’ status does not capture accelerated debt – which may influence a bank’s decision of whether to accelerate. If debt is accelerated, that will be recovered as normal in the order of priorities as a floating charge asset.
Finally, while a CVA proposal or restructuring plan submitted within 12 weeks of the moratorium ending cannot compromise moratorium debts (unless in the case of a restructuring plan with creditor consent) this does not apply to accelerated debt.
The new moratorium may prove to be a very useful tool for companies looking to restructure, but may also prejudice the position of secured creditors. There could well be a shift in in lending practice to address some of the issues the Act poses, and the challenges faced by lenders are further compounded by the increase in the prescribed part in April 2020 and most recently the re-instatement of HMRC as a preferential creditor, which will come into force on 1 December.
Rachael Markham is a professional support lawyer at Squire Patton Boggs.
Emily Davis is a trainee solicitor in the restructuring and insolvency team at Squire Patton Boggs.