New UK Insolvency Legislation and its Potential Impact on the Asset-Based Lending Industry: The New Moratorium

The UK government has announced its intent to introduce new insolvency legislation in response to the coronavirus crisis.

The insolvency and corporate governance proposals have been around for some time and include a number of measures relating to insolvency, including corporate governance, use of subsidiaries, and treatment of dividends. It was in this body of legislation that the increase in the prescribed part to GBP800,000 was included and became law on April 6, 2020.

From what we know about the proposed legislation, the proposed change which is likely to have the biggest impact on the UK ABL and receivables finance industry is the new moratorium and financial restructuring proposal.

The following is taken from the Government Response on Insolvency and Corporate Governance in August 2018 from the Department of Business, Energy & Industrial Strategy:

“The aims of the reforms are to increase protections for creditors and to provide a fair balance between the rights of the company seeking to be rescued and the rights of the creditors seeking payment of the company’s debts. These reforms include:

• Introduction of a new moratorium to help business rescue. This will give those financially distressed companies which are ultimately viable, a period of time when creditors (including secured creditors) cannot take action against the company, allowing it to make preparations to restructure or seek new investment;
• Prohibition of enforcement by a supplier of termination clauses in contracts for supply of goods and services on the grounds that a party has entered a formal insolvency procedure, the new moratorium or the new restructuring plan; and
• Creation of a new restructuring vehicle that would include the ability to bind dissenting classes of creditorswho vote against it.”

The above text raises more questions than answers and also raises some concerning issues regarding the scope and implementation of this piece of legislation.

Based on the 2018 statements, it appears that the process will bind dissenting creditors to a new type of restructuring plan, including cross-class cramdown. It would be a big departure from existing English law to allow such a plan to affect secured creditors without their consent, but we do not yet know the detail of this proposal.

There will be a short moratorium to give companies in difficult times to explore options for rescue. How much time is not clear although two consecutive periods of 28 days have been floated; nor is the extent to which secured and unsecured creditors will be opted in, and if or when secured creditors will be able to act to protect their position including by way of exercising their right as a qualifying floating chargeholder to appoint administrators if applicable.

Originally the proposals suggested that the moratorium was only for solvent companies that were at risk of becoming insolvent, but, under the present circumstances, with many businesses in the UK ravaged by the crisis, you have to consider whether the solvency test will still apply and, if so, how solvency will be measured.

The Enterprise Act introduced the concept of a "company voluntary arrangement” (CVA), whereby a company could achieve a moratorium by a majority vote by value of unsecured creditors providing a time to pay a reduced amount. The CVA did not provide any protection against a winding-up petition unless it was part of a restructuring under administration. This arrangement has had limited success, with many arrangements failing to reach full term.  A big cause of the failures of CVAs is that creditors that have been burnt by the debtor company are often reticent to continue supplying them on credit ("Fool me once, shame on you; fool me twice, shame on me"). The proposed legislation tries to address this by including the protection of suppliers to enable companies to continue trading during the moratorium. How this will be enforced is hard to imagine.

The new moratorium looks like it will afford a company the same protection as a notice of intention to appoint Administrators and actual entry into administration against petitioning creditors, and other litigants, preventing secured creditors from taking steps to enforce security without court or administrator consent while the company formulates restructuring proposals which would bind creditors to an arrangement.

Some of the concepts will have resonance with lenders in the USA because of their perceived similarity with bankruptcy under Chapter 11, although it is not clear how this will fit in with existing UK insolvency practice, which is very different from U.S. Bankruptcy Proceedings.

A major distinction between UK and U.S. asset-based lending practice is the use of receivables purchases in the UK.  A huge advantage of buying the receivables as opposed to lending against them is that they remain remote from the seller company in that company's insolvency. If this continues to be the case, then this will discourage lending against assets other than receivables and move the UK backwards in terms of the deployment of asset-based lending, which has been making significant progress over the last 20 years.

The financing against floating charge assets (specifically inventory) is already diminished as a result of the recent increase in the prescribed part and the reintroduction of Crown Preferences (which has been delayed until December 2020 by recent events) in respect of VAT, PAYE and NIC.  The new proposal introducing the moratorium looks like it will provide further disincentives towards the provision of secured lending right at the point where a stretched business requires support the most. Perhaps the introduction of an equivalent to DIP financing with adequate protection for the secured lender should be considered to allow the secured lender to continue to fund during a moratorium and to mitigate the business risk that the secured creditor simply includes a drawstop event on the commencement of a moratorium.

The unintended consequences of this could be a reduction of capital available to UK businesses at a time when cash flows are going to come under a massive strain for tens of thousands of UK companies.

What the UK government really needs to understand – and soon -- is that the secured lending industry could play a major role in the rehabilitation of the UK economy during and post-crisis.

With very few details of the new moratorium and its explicit objectives to be in place to mitigate the impact of the coronavirus, there are concerns that the proposed legislation will now be rushed through. The adage that "rushed law is usually bad law" is of very real concern here.

SFNet has set up  a task force to work with other trade bodies, including UK Finance, to try to influence legislation towards achieving the best outcome for the UK structured finance industry and UK business in general. Please visit www.sfnet.com for advocacy updates.