By Cathryn Williams, Paul Muscutt, Andrew Knight and Beth Bradley

 

Following our recent post (https://www.restructuringmatters.com/?p=2017&preview=true) on the new Corporate Insolvency and Governance Act 2020 (“the Act”), we now take a closer look at the moratorium and the effects on priority between pre-existing and moratorium lenders.

The New Moratorium – an Overview

The moratorium is intended to give companies breathing space by preventing creditors from taking enforcement action for an initial period of 20 business days. The process is led by a company’s directors and is overseen by an insolvency practitioner in the role of “monitor” who is an insolvency practitioner and an officer of the court.

Eligibility:

(1) the company must be incorporated under the Companies Act 2006 or otherwise capable of being wound up under the Insolvency Act 1986;

(2) the directors consider the company is, or is likely to become, unable to pay its debts;

(3) the monitor considers the moratorium would result in the rescue of the company as a going concern;

(4) the company must not have been subject to insolvency proceedings or have been in a moratorium, CVA or administration within the past 12 months.

Certain companies are specifically excluded from using the moratorium, including banks, insurance companies and parties to capital market arrangements.

There are two routes into a moratorium:

1. In-court process: directors may apply to the court where either there is an outstanding winding up petition or the company is an overseas company (note that until 30 September 2020 the directors can use the out-of-court process below even if there is an outstanding winding up petition, although this temporary exemption does not apply to overseas companies). The moratorium commences when the court order is made.
2. Out-of-court process: directors file the relevant documents in court including the monitors’ certification. The moratorium commences when the documents are filed with the court.

Duration of moratorium?

The moratorium initially lasts for 20 business days (the “initial period”). However, provided certain conditions are met, the initial period may be extended:

1. by the directors, without the consent of creditors, for a further 20 business days after the end of the initial period (note that the extension must be applied for before the initial period ends);
2. by the directors, with creditor consent, for a maximum period of 364 days, including the initial period. Extension with creditor consent may occur more than once;
3. by the court, on application by the directors, for which there is no maximum period and which may occur more than once.

Effects of moratorium:

The moratorium allows the directors to retain control of the company, which cannot be placed into an insolvency procedure except at their instigation.

Other aspects of the moratorium broadly follow the administration moratorium: landlords cannot forfeit without court permission; security cannot be enforced without court permission (other than certain types of financial collateral); no steps may be taken to repossess goods in the company’s possession under hire-purchase agreements without court permission; and legal processes against the company cannot be commenced or continue without court permission (except certain employment claims).

Significantly, floating charge holders cannot give notice to crystallise their floating charge or otherwise restrict the disposal of floating charge assets during the moratorium. If a floating charge holder’s ability to crystallise their charge is time-limited and expires during the moratorium, this time is extended to as soon as reasonably practicable after the end of the moratorium or (if later) the day on which the floating charge holder is notified of the end of the moratorium.

The Act provides that new security granted during the moratorium can only be enforced if the grant of that security was agreed to by the monitor, but this is in any event subject to the rule, mentioned above, that security (other than certain types of financial collateral) cannot be enforced during the moratorium without court permission.

The Act imposes certain restrictions on a company during the moratorium:

• Obtaining credit: the company must inform a potential provider of credit of more than £500 that the moratorium is in force; the company and the directors commit an offence if they fail to do so.
• Granting security: new security can only be granted or created with the monitor’s consent, which should be given only if the monitor thinks it will support the rescue of the company.
• Entering into market contracts: the company may not enter into market contracts, financial collateral arrangements and certain other market arrangements. The company and the directors commit a criminal offence if they do so.
• Payment of certain pre-moratorium debts: the company may not pay pre-moratorium debts that are subject to a payment holiday (see further below) which (in total) exceed the greater of £5,000 or 1% of the company’s total unsecured debts at the start of the moratorium, unless one of the following applies:
  • the monitor consents;
  • payment is pursuant to a court order or required in relation to a court-sanctioned disposal of hire-purchase or charged property.
• Disposal of property: the company may dispose of its property if one of the following applies:
  • the monitor consents;
  • the disposal is made in the ordinary course of business;
  • the disposal is pursuant to a court order.

Termination of the moratorium:

The monitor can terminate the moratorium by filing a notice at court and they must do so if they are of the opinion that:

1. the moratorium is no longer likely to result in the rescue of the company as a going concern;
2. the objective of rescuing the company as a going concern has been achieved;
3. the monitor cannot carry out his or her functions because the directors have not provided the monitor with necessary information;
4. the company is unable to pay moratorium debts that have fallen due or pre-moratorium debts without a payment holiday (see further below). As most pre-existing lending will fall within the definition of moratorium debts or pre-moratorium debts without a payment holiday, incumbent lenders may have an element of control over the process; if the moratorium constitutes an event of default that automatically accelerates or permits the lender to opt to accelerate the entire debt, then the monitor may have to bring the moratorium to an end if the company is not in a position immediately to pay such debts. This is likely given that, in order to enter the moratorium, the directors have confirmed that the company is, or is likely to become unable to, pay its debts.

The moratorium will also terminate automatically if:

1. the company enters into an insolvency process;
2. a restructuring plan or scheme of arrangement is sanctioned;
3. c court order to that effect is made;
4. the term of the moratorium expires.

Categories of Debt:

The Act divides the company’s debts into the following three categories:

1. Pre-moratorium debt with a payment holiday

With important exceptions (see below), companies in moratorium benefit from a “payment holiday” under the moratorium provisions for debts that existed before the moratorium or, if the debt did not itself exist, the obligation under which the company becomes liable to pay that debt existed before the moratorium.

2. Pre-moratorium debt without payment holiday

(a)        Relevant debts

Certain pre-moratorium debts that are not subject to a payment holiday and must continue to be paid during the moratorium. These are debts that fell due before, or fall due during, the moratorium and relate to:

• the monitor’s remuneration or expenses;
• goods or services supplied during the moratorium;
• rent in respect of a period during the moratorium;
• wages or salary arising under a contract of employment, insofar as they relate to a period of employment before or during the moratorium;
• redundancy payments;
• debts or other liabilities arising under a contract or other instrument involving financial services. Importantly, this includes a loan agreement, with the consequence that, unless otherwise agreed, capital and interest payments due to lenders are still payable during the moratorium and a failure to make such payments may force the monitor to terminate the moratorium (see further below).

(b)       Priority pre-moratorium debt

Priority pre-moratorium debt includes all pre-moratorium debt without a payment holiday (i.e. everything listed in (a) above) but excludes “relevant accelerated debt”. Relevant accelerated debt is any pre-moratorium debt that falls due: (1) between the date on which the monitor’s statement (that the moratorium is likely to result in the rescue of the company) is made and the last day of the moratorium and (2) as a result of the operation or exercise of an acceleration or early termination clause.

The exclusion of “relevant accelerated debt” from the category of debts having super priority in a subsequent insolvency was a late amendment to the Bill as it made its way through Parliament.   It was introduced to address concerns that financial creditors could accelerate pre-moratorium debt without a payment holiday during the moratorium, cause the moratorium to fail and by so doing obtain super-priority status for the full amount owed to them.

3. Moratorium debt

Moratorium debt includes any new debt that arises during the moratorium (other than by reason of an obligation incurred before the moratorium came into force) or a debt to which the company becomes or may become subject after the end of the moratorium by reason of an obligation incurred during the moratorium.

Priority

Super-priority in a subsequent Liquidation

Where proceedings for the winding up of a company begin within 12 weeks following the end of the moratorium, the liquidator must make a distribution to the creditors of the company in respect of moratorium debts and priority-pre moratorium debts (which does not include relevant accelerated debt) in priority to all other claims, save for the prescribed fees and expenses of the official receiver acting in any capacity in relation to the company. The liquidator must realise any property required to enable them to make such distributions.

Super-priority in a subsequent Administration

If within the 12 week period following the end of the moratorium the company enters administration, the administrator must make a priority distribution in respect of unpaid moratorium debts and priority-pre moratorium debts (which does not include relevant accelerated debt).  This distribution is paid out after fixed charges but in priority to insolvency practitioner expenses and remuneration, preferential creditors, the prescribed part and any party holding existing floating charge security.

The implications of these new priority arrangements are (1) that any new lender coming in to fund the company during the moratorium will have an enhanced priority for any sums due to them at the end of the moratorium and (2) this will dilute the availability of floating charge assets to pre-existing secured lenders given that they come last in the queue.

CVAs/Schemes of Arrangement

If a CVA or scheme of arrangement occurs within 12 weeks of the termination of the moratorium, note that moratorium debts and priority pre-moratorium debts cannot be compromised in the CVA/scheme.

What if there are insufficient assets to pay moratorium debt and priority pre-moratorium debt in full?

The Act provides that moratorium debts and priority pre-moratorium debts are payable in the following order of priority:

1. first, amounts payable in respect of goods or services supplied during the moratorium under a contract where, but for the new rules protecting supplies of goods and services, the supplier would not have had to make that supply;
2. second, wages or salary arising under a contract of employment;
3. third, other debts or other liabilities apart from the monitor’s remuneration or expenses;
4. fourth, the monitor’s remuneration or expenses.

The above priority provisions may leave very limited floating charge proceeds available to pay the costs and expenses of the subsequently appointed administrators or liquidators and preferential debts. If the proceeds are insufficient to pay these priority sums in full, given that the monitor’s unpaid fees rank last in the waterfall, the monitor may also find himself unpaid.

New Lending during moratorium

To the extent that new loans are advanced to the company during the moratorium which are unpaid at the end of the moratorium, such loans will have super-priority (as moratorium debt) and will be paid out of realisations ahead of a lender holding existing floating charge security. If the moratorium debt is significant, this may have a serious impact on the likelihood of an existing secured lender making any recovery in respect of its floating charge security.

How can existing lenders best safeguard their position?

As noted above, debts due to a lender fall within the definition of pre-moratorium debts without a payment holiday which the company must continue to pay during the moratorium. If the lender does not support the moratorium, it may be possible for the lender to accelerate its debt or request immediate repayment of “on demand” facilities. The company is likely to be unable to satisfy such demand, and as such, the monitor will have little option but to terminate the moratorium. Note, however, our comments above that this accelerated debt is not included in the super-priority which follows an insolvency within 12 weeks of the end of the moratorium.

Note that if a debt is accelerated before the monitor’s statement is filed, it would not fall within the definition of relevant accelerated debt. As such, whilst it could not prevent directors filing for a moratorium, that debt would be a priority pre-moratorium debt and would be payable on a priority basis in the event of an administration or liquidation commencing within 12 weeks of the end of the moratorium.

We recommend that going forward, lenders include a requirement in all new or restated facility documents that (1) the company must consult with them prior to any monitor’s statement being filed, and (2) the identity of the monitor has to be agreed with the lender prior to them being appointed. This will allow lenders to retain an element of control both in relation to the moratorium procedure and also ensure that they can accelerate their debt or take enforcement action against the company.

The Act leaves questions unanswered and we anticipate that many issues will arise in its implementation. The effect of the Act has been to rush through significant changes to the priority of the distribution of a company’s assets without any serious efforts to engage with lenders to work out the implications it may have on a lender’s appetite to lend.