CIGA – much ado about nothing?

The Act brings in both temporary measures designed to protect businesses from the worst effects of Covid-19 but also permanent measures that were the subject of extensive consultation before the pandemic hit. These provisions were introduced to address apparent deficiencies in English insolvency law in comparison to our more enlightened brethren across the ocean. As analysed below, I think this Act may be more talk than walk, however.

This article does not address the supplier insolvency termination nullification provisions in CIGA which are addressed by the author and a colleague here.

Temporary changes to creditor enforcement rights

• Statutory demands served between 30 March and 30 September 2020 are ineffective
• Nor will it be easy for creditors to get round the ban on statutory demands by presenting a winding up petition based on cashflow insolvency evidenced by a debtor’s failure to meet a letter of demand not in statutory demand form. While cashflow winding up petitions have not been rendered wholly ineffective in this period, creditors who present a winding up petition before 30 September must show they have reasonable grounds for believing the pandemic has not had a financial impact on the debtor (an almost impossible task) or that the grounds would still have still existed even without the pandemic. There has been already been caselaw on this test setting a high bar for any creditor.

These are very real changes to the law, albeit temporary, and they make it extremely difficult for a creditor to pursue a debt against a debtor company through the winding up court.

Temporary change to wrongful trading law

The wrongful trading point is the point at which a director knew or ought to have known that there was no reasonable prospect of the company avoiding insolvent administration or liquidation. At this point directors are potentially personally liable for the company’s debts unless they can show they took every available step to minimise potential loss to the creditors.

CIGA introduces an assumption that a director is not responsible for a worsening of financial position between 1 March 2020 and 30 September 2020. However, CIGA does not bring in any changes to other director duties, including the duty to act in the best interests of the creditors as a whole and so this duty remains in the March-September period. It is quite unclear how this continuing duty interacts with the wrongful trading suspension. The government has published guidance on the legislation but the examples they give of where the suspension may assist a director do not, in this writer’s eyes, even constitute examples of wrongful trading.  This change to the law may be more window dressing than substantive.

Permanent changes – two new insolvency procedures

Moratorium

This new procedure enables a company to avail itself of a moratorium similar in scope to an administration moratorium including preventing secured creditor enforcement and forfeiture by landlords.

The main difference from administration is that, whereas in administration the directors’ powers effectively cease on entry into administration, on entry into a moratorium the directors remain in control of the company subject to oversight by a licenced insolvency practitioner acting as a monitor. 

A company can avail itself of the procedure simply by filing notices at court save where there is an outstanding winding up petition against the company or it is an overseas company when a court application is required.

This procedure has been introduced to address the concern that the English system has no equivalent to US Chapter 11 “debtor in possession” proceedings where the management remains in control of the company rather than coming under the control of an independent insolvency practitioner.

This concern may be more apparent than real, however:

• English law already boasts two insolvency procedures in which the management can remain in control, namely the company voluntary arrangement (“CVA”) procedure and the scheme of arrangement procedure. It is true that these procedures require the management to put together proposals for compromising liabilities whereas the new moratorium procedure can be entered without such proposals yet being in place. Clearly, however, CIGA envisages the moratorium as a short-lived process rather than the often long lasting US Chapter 11 proceedings. It initially lasts for just 20 days, although it can be extended without consent for a further 20 days, and extended with creditor consent for a year. The clear intention is that this procedure provides a short breathing space in which management can remain in control while plans are put together to compromise liabilities, perhaps through the existing CVA or scheme of arrangement procedure. Unlike Chapter 11, the moratorium is likely a stepping stone only
• And one may wonder whether, if it is just a stepping stone, that stepping stone was even needed. A moratorium has been in existence for small company CVAs since 2000 yet rarely used
• Even if the moratorium is intended as a longer lasting debtor in possession proceeding, it is arguable that the pre-CIGA law anyway permits such debtor in possession moratoria without the need to formulate compromise proposals. It is possible for an administrator to consent to the directors retaining management powers under a consent protocol (the so-called “light touch” administration) which largely replicates a debtor in possession model and which has been pursued in recent administrations including Debenhams, albeit without great success

It is very early days but this writer is not aware of the procedure having yet been used and he suspects it may prove to be something of a damp squib.

New arrangement and reconstruction procedure

The arrangement and reconstruction procedure closely resembles the old scheme of arrangement procedure available under the company legislation. In particular, (1) it can be used as a debtor in possession tool with the directors remaining in control of the company; (2) the persons proposed to be affected by the procedure will be broken down into classes for voting purposes; and (3) there will be two court hearings, the first to examine the class break down and the second to determine whether the relevant requirements for the proposal to take effect have been met.

The main differences from the current scheme procedure are that:

• The court may exclude from voting those creditors or members who have no genuine economic interest in the company (albeit caselaw has confirmed that an equivalent effect can be achieved even under old schemes)
• The court may still sanction a scheme under the new procedure even if one or more classes have rejected the scheme, provided:
  • the court is satisfied that none of the dissenting classes are any worse off under the plan than they would be in the event of the “relevant alternative”
  • the plan has been agreed by another class of voters who would receive a payment, or have a genuine economic interest in the company in the event of the relevant alternative.

The relevant alternative is defined as whatever the court considers would be most likely to occur in relation to the company if the scheme were not sanctioned by the court.

This has the effect that, unlike the existing scheme of arrangement:

• under the new scheme junior classes (eg junior secured creditors) can be crammed down without their consent even if they have an economic interest in the company. (Albeit even under an old scheme, a similar effect could be achieved in certain circumstances through the use first of an administration procedure followed by an old scheme provided there was a security enforcement structure in place that allowed the cram down)
• a “cram up” can occur wherein a scheme is sanctioned that has been approved by a junior class but rejected by a senior class.

The ability to “cram up” is indeed an innovation and seemingly goes beyond even the US system which has in effect an absolute priority rule in which senior creditors must get paid in full before junior creditors receive anything save for permitted minor deviations. However, the creditor hold out example given in the government’s guidance in justification of the need for “cram up” seems somewhat contrived and we await a real life example of such “cram up” before being able to pass judgment on its utility.