Avoiding a Cliff-edge of Insolvencies? Observations from the recent House Of Lords debate on extension of creditor restrictions

Last week's debate in the House of Lords provided a good opportunity to get an indication of the government's current thinking on continuing restrictions on creditor enforcement. Of particular concern is the threat of a looming cliff-edge of insolvencies when the restrictions are finally lifted. Cliff-edge or no, what is clear is that we are approaching a turning point and there is an unprecedented amount of debt in the market, threatening to cripple otherwise viable companies. Our Restructuring team discuss these issues in the article below, and stress that directors and companies, not just government, will need to take pro-active steps to ensure a successful post-COVID recovery. 

Temporary restrictions on using statutory demands to wind up companies and other restrictions on company winding-up petitions have been in place since they were first introduced under the Corporate Insolvency and Governance Act 2020 (CIGA) in June of 2020. 

These measures, like others in CIGA, are aimed at supporting directors in guiding their companies through the period in which business is being affected by the current pandemic and are designed protect many viable companies from creditor enforcement action during unprecedented trading conditions. Initially, they were to last until the end of September 2020, but have so far been extended twice: firstly to 31 December 2020 and secondly to 31 March 2021. 

Covid Restrictions - A balancing act

As our Restructuring team have noted previously, with these measures the government appears to be trying to strike a balance between severely restricting the trading of businesses through COVID-lockdowns on the one hand, and shielding them from the repercussions of depleted cash-flow on the other (see our article here). 

One way to try to understand the motivations driving the government's approach to such a balancing act is to look behind the scenes at the parliamentary debates which ultimately inform shifts in government policy. Last week provided a good opportunity for doing so, with the House of Lords debating (retrospectively, of course) approving the statutory instrument which gave effect to the most recent extension of CIGA's temporary restrictions on creditor enforcement. 

The contributions of the Lords during that debate, while not a true blueprint of government policy, may at least provide some indication of the inclinations of parliament on some crucial insolvency and restructuring questions. Read on for our Restructuring team's discussion of the key points of interest.

House Of Lords Debate - The Key Points 

1. HMRC: as of 1 December 2020, HMRC enjoy preferential status as a creditor, meaning that they rank ahead of ordinary unsecured creditors in the event of a company's insolvency. This has been widely decried as having potentially significant adverse effects on the UK's finance market and R3, the UK's leading association of insolvency and restructuring professionals, has been lobbying parliament firmly on this. 

This lobbying appears to have been somewhat successful, as HMRC's new preferential status was raised by a number of peers during the debate, with it being stressed that HMRC will inevitably have a crucial role to play in being co-operative and engaging with a supportive way on proposed COVID-restructurings in the months and years to come. This is even more apparent when the huge scale of deferred tax liabilities is considered, which frequently points to HMRC being one the largest creditors for many companies immediately post-COVID. For example, there is an estimated £28.2bn of VAT falling due between March and June 2020 agreed to be deferred by HMRC to 31 March 2021. 

Concern was raised over HMRC's ability and capacity, in terms of staffing and resources, to properly respond to insolvencies in a constructive way: i.e. will it be able to make the proper assessments to allow it to take a longer term view when approached by companies seeking to restructure?

Unfortunately, the government's Minister present for the debate did not engage with these points substantively, stating: 

"that, of course, does not concern these particular regulations. We work closely with the regulators, the courts and the insolvency profession to ensure that they will be able to scale up and cope with the expected increase in insolvencies."

2. Piecemeal CIGA extensions: a number of peers expressed confusion as to why the extension of the restrictions on creditor action were being dealt with by regulations separate to the ones dealing with other temporary extensions to CIGA (for example the suspension of wrongful trading, which has recently been extended again to 30 April 2021), with arguments made that they should all be dealt with in the round.

Concern was also expressed around the piecemeal approach to extensions, and the lapse of the wrongful trading suspension from 30 September to 26 November (when it was quite suddenly re-instated again), with a question asked as to whether the Minister could confirm that directors will have protection for actions taken during that period.

These all seem fair points, and it would certainly make logical and practical sense to deal with both the winding up restrictions and the wrongful trading suspension together. However, the Minister did not respond to these queries during the debate.

3. Avoiding the cliff-edge: in response to several questions on what is being done to avoid a 'cliff-edge' for struggling companies when restrictions to creditor enforcement are ultimately lifted, the Minister stated:

"the government recognise the cliff-edge scenario, which would involve the accumulation of unpaid debts becoming due when restrictions and government fiscal support expire, and I can tell the noble Lords that work is ongoing to develop measures to address what we are aware is a potential issue."

Precisely what is meant by this statement is unclear, and this is something to keep an eye on for further announcements from the government. 

A Turning Point - Time To Plan Recovery 

Cliff-edge or no, what is clear is that we are approaching a turning point: the pandemic has so far seen GDP fall 11.1% (year on year), and companies across the most affected sectors are continuing to face new and unexpected liabilities (for example, see our note of the particular challenges being faced by the UK's entertainment industry.

Over £68bn of emergency, government-backed lending has been extended to companies across the UK, and with an estimated £4.5bn of accrued arrears of commercial property rent for 2020 sitting unpaid, alongside the deferred tax liabilities discussed above and the unchallenged defaults on existing, pre-COVID lending, there is an unprecedented amount of debt in the market

Directors and companies, not just government, will need to take proactive steps to ensure they are mitigating against a potential hammer blow of recoveries actions. Early and frank engagement with creditors will be key, accepting the untenable situation they may be in but making a persuasive case to creditors that they are a successful enterprise, unexpectedly derailed by an unforeseen global pandemic, and one which will bounce back as soon as normal service and customer demand resumes. 

Due to the underlying commercial viability of many of the companies that have been hit by COVID, the most appropriate tool may be a Company Voluntary Arrangement (CVA), which, as the name suggests, involves a company approaching its creditors and voluntarily entering into a contractual arrangement whereby a compromise is reached on their outstanding debts to give the business time to begin trading profitably again. 

With a new model CVA for SMEs recently published, now could be the perfect opportunity for companies to familiarise themselves with this tool and engage with creditors before time runs out. This new model CVA is specifically designed for a rescue of viable businesses that have suffered due to COVID and offers an opportunity for breathing space to recover. Read more about it here.

Alternatively, a more involved insolvency process might be an option, such as a pre-packed insolvency, which can allow the directors of a company to settle the debts of the existing company and then sell on the business and assets to themselves, re-incorporated as a new company.

Our Restructuring team are always happy to take a call to discuss these issues and to explore possible options for ensuring a successful post-COVID recovery for your business.