Shortly after the onset of the COVID-19 pandemic in the UK, the UK government announced proposed changes to UK insolvency law to provide relief for otherwise economically viable businesses wrestling with the economic shocks of the crisis.1 On 20 May 2020, the UK government published the Corporate Insolvency and Governance Bill (the “Bill”) to implement these and other changes to UK insolvency law.2 The changes include the temporary suspension of wrongful trading rules, the introduction of new restructuring processes and protecting access to essential suppliers for companies in financial difficulties.
The Bill was introduced to the House of Commons and given its first reading on 20 May 2020. The Government intends to ask Parliament to expedite the parliamentary progress of this Bill using the fast-track process.3
One of the key rationales for securitisation transactions is that investors are exposed primarily to the credit risk of the receivables (rather than, for instance, the credit risk of the originator of the receivables), and for this purpose it is important to ensure that the SPV issuer does not interrupt this exposure by inadvertently becoming insolvent (i.e. it is “insolvency remote”).4
This legal update considers the proposed changes to UK insolvency law contained in the Bill, in light of the importance of insolvency remoteness to securitisation transactions, and considers insolvency remoteness more generally given that the economic stress many securitisations transactions are now facing may put this important principle to the test.
Please refer to Mayer Brown’s COVID-19 Response Blog for detailed analysis of the Bill outside the context of securitisation transactions.5
Proposed insolvency laws reforms
The initial proposals were contained in an announcement by the Business Minister Alok Sharma on 28 March 2020, which referred to the existing proposed reforms to UK insolvency law first put out for consultation by the Government in 2016. The Bill represents an acceleration of those reforms, with extra measures to provide support for companies facing the unexpected effects of the pandemic.
The relevant proposed changes include:
- a temporary suspension of the wrongful trading provisions, to be applied retrospectively from 1 March 2020 until 30 June 2020 (or one month after the coming into force of the Bill, whichever is the later), to allow directors to continue trading through financial difficulties without the threat of this type of personal liability and other measures to protect companies from aggressive creditor action;
- a new streamlined, free-standing moratorium for companies in financial distress (including, but not limited to, those affected by COVID-19), providing relief against creditor action, to give such companies time to explore options for a rescue or restructure (including provisions to ensure companies have continued access to their key supplies during the moratorium); and
- a new restructuring plan, binding all creditors to that plan even if they vote against it (a “cross-class cram-down”), including safeguards for creditors and suppliers to ensure they are paid while a solution is sought.
There is no duty under English law for a company director to file for administration or liquidation if a company is insolvent. Compare this to the position in various European jurisdictions, where there is an obligation to file for insolvency proceedings in the case of (i) illiquidity (inability to pay debts as they fall due) – e.g. France and Belgium, (ii) balance sheet insolvency (liabilities exceed assets) – e.g. Italy, Austria, Germany or (iii) loss of a proportion of capital – e.g. Switzerland.6
Wrongful trading is one of the tools employed by English law, alongside the reorientation of directors’ duties towards creditors7, to balance the interests of company stakeholders as a company approaches insolvency. Whilst there is no obligation for a company director to file for insolvency proceedings as insolvency approaches, the spectre of liability for wrongful trading and the general duty to consider the interests of creditors may effectively force the hand of a director where there is no realistic prospect of trading to safety and the formal recovery and distribution processes of insolvency proceedings are likely to maximise returns to creditors. This balancing act is especially difficult in the current crisis as there is a great deal of uncertainty around trading conditions.
In the case of highly leveraged securitisation transactions or where the financial performance of a transaction has deteriorated such that reserves or other credit support has been exhausted, the liabilities of an SPV issuer may exceed its assets8, bringing an inchoate liability for wrongful trading into sharp focus for the directors of the SPV. A premature filing for insolvency (e.g. where there has been a large temporary deterioration of performance but the transaction is expected to recover over the medium term) would have a disastrous effect on such transactions.
A director may be required by a court, upon an action by a liquidator or an administrator, to contribute to the assets of an insolvent company under s.214 of the Insolvency Act 1986 (“IA”) where: (i) a company has entered insolvent liquidation or insolvent administration, (ii) the director knew, or ought to have concluded, that there was no reasonable prospect that the company would avoid such liquidation or administration and (iii) the director is found to have failed to take every step with a view to minimising the potential loss to the company's creditors as they ought to have taken.
S.213 IA imposes liability on participants in “fraudulent trading”, where the business of the company has been carried on with the intent to defraud creditors, or for any other fraudulent purpose. It is important to distinguish wrongful and fraudulent trading, where personal liability may be imposed, from other “antecedent transaction” provisions, such as transactions at an undervalue (s.238 IA) or preferences (s.239 IA). If the conditions for the application of those provisions are fulfilled in relation to a transaction, a court may make such order as it thinks fit for restoring the position to what it would have been if the company had not entered into that transaction.9
COVID-19 changes to wrongful trading
The Bill effectively suspends the wrongful trading provisions for 3 months from 1 March 2020 to 1 June (the “Relevant Period”). This is achieved by providing that a court will not hold a director responsible for any worsening of the financial position of a company or its creditors during the Relevant Period.10
The provisions have been suspended for all companies, not just specifically for those directly affected by COVID-19, e.g. those businesses required to close under The Health Protection (Coronavirus, Business Closure) (England) Regulations 2020. Directors should be aware that even though the changes have been publicised as having effect from 1 March 2020, liability will not be removed as a matter of law until the Bill is enacted.
Certain companies are excluded from the suspension, including11:
- securitisation companies, which are defined as a securitisation company within the meaning of the Taxation of Securitisation Companies Regulations 2006 (S.I. 2006/3296);
- parties to capital market arrangements,
In the case of securitisation transactions where restructuring measures are contemplated due to poor financial performance, the suspension may not only bring relief for directors of SPV issuer companies concerned with potential liability for wrongful trading, but also reduce the risk of a premature filing for insolvency proceedings where poor financial performance of a transaction is only expected to be temporary. In terms of personal liability for directors, the beneficial effects of a waiver of the wrongful trading provisions is tempered by the fact that other provisions moderating the behaviour of directors in distressed scenarios remain in place. These include: (i) the general duty to act in the best interests of the company (represented by creditors as insolvency approaches), (ii) fraudulent trading and (iii) potential disqualification as a director. The risk of personal liability remains for directors of such SPV issuers during this period of Covid-19 uncertainty.
Successful actions for wrongful trading are rare in practice, due to the difficulty in proving that a director knew or ought to have known there was no reasonable prospect of avoiding insolvency or such director can show he did everything possible to minimise losses to the company. The relevance of wrongful trading in practice is the “nudge effect” it has on directors to file for insolvency to protect against liability in distressed scenarios. To the extent the changes mitigate against this tendency, they may protect the insolvency remoteness of a structure.
COVID moratorium and restructuring process
The government’s proposals also refer to a new interim moratorium, to protect companies experiencing financial difficulties as a result of COVID-19, and the creation of a new restructuring procedure, allowing those companies to effect a turnaround. The announcement draws on similar proposals originating in a review of UK insolvency provisions by the Department for Business, Energy & Industrial Strategy in May 2016 (the “Review of the Corporate Insolvency Framework”)12, and subject to consultation most recently in August 2018.13
Several elements of the new process are still subject to consultation and a draft Bill is awaited, so market commentators are doubtful that the government will be able to fast-track a completely new restructuring process to provide immediate assistance to companies currently facing financial distress as a result of COVID-19. As a result, the remainder of this legal update focuses on the potential new moratorium.
Details of the moratorium in the government announcement are brief, but the outlines can be discerned from the existing proposals for a new moratorium in the Review of the Corporate Insolvency Framework. Those proposals14 involve establishing a new out-of-court moratorium procedure to give financially distressed, but viable, companies the time to consider restructuring options. A key objective is to reduce the cost and time of restructurings for small companies. The moratorium would not be available for companies which are already insolvent. The moratorium would be overseen by an insolvency practitioner “monitor” and last initially for 28 days, which may be extended for a further 28 days if the initial qualifying conditions continue to be met, and for an additional period by the court.15
It is unclear whether the current changes will involve fast-tracking the existing proposals or borrowing from them to implement similar temporary provisions for companies affected by COVID-19. The City of London Law Society Insolvency Sub-Committee has for instance published proposals16 to amend or suspend existing insolvency law provisions which would give companies the benefit in practice of a moratorium. These include: (i) allowing directors of affected companies to make an e-filing with court which would which start a 90 day grace period in relation to winding up petitions etc and/or (ii) giving companies suffering COVID-19 related financial difficulties the ability to obtain a moratorium similar to that available under para. 44 of Schedule B1 to the Insolvency Act 1986 in relation to administrations.
Impact on transactions
Non-petition clauses, where all of the key transaction creditors of an SPV issuer (noteholders, trustee, service providers, hedge counterparty, etc.) agree that they will not petition for the insolvency or other winding-up of the SPV until the transaction obligations are paid in full, are ubiquitous in securitisation transactions. Non-petition clauses are important to secure the insolvency remoteness of an SPV issuer.17 When firm details about the form of moratorium and restructuring process are known it will be necessary to update or draft these non-petition clauses so that they capture any new insolvency process. This is important so that, as far as is permissible, they prevent any insolvency process being initiated which may interfere with the running of the SPV, and thereby reinforce its insolvency remoteness . The SPV issuer does not undertake against taking such insolvency actions in respect of itself (and the effectiveness of any such undertaking is uncertain), so the option of applying for a new COVID moratorium or restructuring process remains open for directors of the SPV.
Where drafting counsel are giving an enforceability opinion in relation to the transaction documents it will be important to consider whether that opinion is affected by any COVID moratorium measures. Most directly, any available moratorium would likely involve the prohibition of enforcement of security against the SPV issuer. It will be important to consider also the effect any moratorium has on the hardening/look-back periods for the antecedent transactions rules. No detail is contained on this in the government proposals, but it seems likely that any hardening period would be extended to include any period in which a company is subject to a COVID moratorium. The susceptibility of transactions to challenge under the antecedent transaction rules (e.g. as a preference or a transaction at an undervalue) is an important part of the true sale analysis of sales of receivables to the SPV issuer, and therefore its insolvency remoteness.The transaction documents in a securitisation will often contain representations from transaction parties that they are not insolvent or subject to an insolvent event. The drafting of these events differ from transaction to transaction, but are often very wide. It will be important to ensure that they capture any new COVID moratorium or restructuring process.
1 https://www.gov.uk/government/news/regulations-temporarily-suspended-to-fast-track-supplies-of-ppe-to-nhs-staff-and-protect-companies-hit-by-covid-19 and House of Commons Briefing Paper Number 8877, 31 March 2020 - Coronavirus: changes to insolvency rules to help businesses
2 https://publications.parliament.uk/pa/bills/cbill/58-01/0128/20128.pdf and Corporate Insolvency and Governance Bill Explanatory Notes at https://publications.parliament.uk/pa/bills/cbill/58-01/0128/en/20128en.pdf
3 Corporate Insolvency and Governance Bill Explanatory Notes at para. 78.
4 SPVs are typically arranged so that voting rights are not the dominant factor in deciding who controls the entity, the activities of the company being largely laid out in the transaction documents or its constitutional documents.
6 See Principles of International Insolvency, 3rd Ed, 2019, Philip Wood.
7 In the ordinary course of business, pursuant to s.172 of the Companies Act 2006 (“CA 2006”) a company director is under a duty to act in good faith in the best interests of the company. S.172(3) CA 2006 makes this duty subject to any rule of law requiring a director to have regard to the interests of creditors. Under the common law (e.g. Liquidator of West Mercia Safetywear Ltd v Dodd and another  4 BCC 30; BTI 2014 LLC v Sequana S.A., Antoine Courteault, & others  EWCA Civ 112), as a company approaches insolvency a director is required to have primary regard to the interests of creditors of the company, on the basis that in an insolvency the equity of a company would be reduced to zero and creditors are the group with the primary financial interest in the company.
8 For the purposes of wrongful trading, only the balance sheet test is relevant for testing whether a company is insolvent - s.214(6) IA 1986 (insolvent liquidation) and s.246ZB(6)(a) IA 1986 (insolvent administration).
9 The applicability of antecedent transaction provisions (transactions at an undervalue, preference, etc.) is relevant to insolvency remoteness from the https://publications.parliament.uk/pa/bills/cbill/58-01/0128/20128.pdfthere is a “true sale” of receivables from the originator to the SPV issuer. A true sale of receivables requires (among other things) that the sale cannot be reversed because they were a transaction at an undervalue or a preference. These matters are typically considered in reasoned true sale legal opinions given in relation to transaction documents by legal counsel to the transaction.
10 Clause 10(1) of the Bill.
11 Clause 10(3) of the Bill refers to a list of “Eligible Companies” in Schedule ZA1, which under Schedule 1 of the Bill replaces Schedule A1 of the Insolvency Act 1986. Other companies which are not “Eligible Companies” include banks, investment firms, payment institutions, recognised investment exchanges, clearing houses and CSDs.
12“A Review of the Corporate Insolvency Framework: A consultation on options for reform”, May 2016, Department for Business, Energy & Industrial Strategy.
13“Insolvency and Corporate Government: Government Response”, August 2018, Department for Business, Energy & Industrial Strategy
14 “Insolvency and Corporate Government: Government Response”, August 2018, Department for Business, Energy & Industrial Strategy
15It will be important to consider what effect any moratorium has on the look back periods for the “antecedent transactions” rules. To avoid abuse it is likely that any look back would not include any temporary moratorium.
16 “Proposals for Mitigating the Short Term Effects on Viable Businesses of COVID-19” March 2020, City of London Law Society Insolvency Sub-Committee
17There is no objection to non-petition clauses under English law – see e.g. Re Colt Telecom Group  EWHC 2503.