Covid-19 Update: Temporary changes to insolvency laws

Covid-19 Update: Temporary changes to insolvency laws

The unfortunate reality is that COVID-19 is going to impact many businesses, potentially forcing them into insolvency. To help businesses stay afloat during this period, the Government will be making temporary changes to some of our insolvency laws.

The temporary changes include:

  • Giving directors of companies facing significant liquidity problems because of COVID-19 a ‘safe harbour’ from insolvency duties under the Companies Act 1993;
  • implementation of business debt hibernation, which will enable businesses affected by COVID-19 to place existing debts into hibernation until they are able to start trading normally again;
  • allowing the use of electronic signatures where necessary due to COVID-19 restrictions;
  • giving the Registrar of Companies the power to temporarily extend deadlines imposed on companies, incorporated societies, charitable trusts, and other entities under legislation; and
  • giving temporary relief for entities that are unable to comply with requirements in their constitutions or rules because of COVID-19.

How the measures will work:

Safe Harbour:

The changes will provide a safe harbour for directors from sections 135 and 136 of the Companies Act 1993.  Section 135 provides that a director must not carry on or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors.  Section 136 of the Act provides that a director must not agree to an obligation unless they believe on reasonable grounds that the company can carry out the obligation.

The safe harbour will mean that directors’ decisions to keep on trading, as well as decisions to take on new obligations, over the next 6 months will not result in a breach of duties provided that the following requirements are met:

  1. In the good faith opinion of the directors, the company is facing or is likely to face significant liquidity problems in the next 6 months as a result of the impact of the COVID-19 pandemic on them or their creditors;
  2. the company was able to pay its debts as they fell due on 31 December 2019; and
  3. the directors consider in good faith that it is more likely than not that the company will be able to pay its debts as they fall due within 18 months.

Business Debt Hibernation Scheme:

The Government is introducing a Business Debt Hibernation Scheme which it believes will:

  • encourage directors to talk to their creditors with a view to putting together a proposal for  putting the company’s debts in into hibernation;
  • to allow directors to retain control of the company, rather than passing control to an insolvency practitioner (receiver or liquidator);
  • to provide certainty to new creditors that they won’t have to repay any money they receive (under the voidable transactions regime), so as to encourage businesses to continue transacting with businesses.

The Business Debt Hibernation Scheme will work as follows:

  • Firstly, directors will have to meet a threshold before being able to access the Business Debt Hibernation Scheme and putting a proposal to their creditors. The Government is yet to announce what this threshold will be, however it is anticipated that directors will have to establish that their company would have passed the solvency test under the Act had it not been for COVID-19, and that it is in the best interests of the company to implement Business Debt Hibernation.  
  • Secondly, creditors will have a month from the date of notification of the proposal to vote on it, with the proposal going ahead if 50% (by number and value) agree;
  • Thirdly, there will be a one month suspension on the enforcement of debts from the date that the proposal is notified and a further six month suspension if the proposal is passed.

Once agreed upon by the creditors, the Business Debt Hibernation Scheme would be binding on all creditors and would be subject to any conditions agreed to with the creditors. Subject to the agreement with the creditors and any restrictions within it, a business would be able to continue to trade as normal during the Business Debt Hibernation Scheme period.

To encourage transactions with businesses who have entered into a Business Debt Hibernation Scheme, it has been proposed that any further payments, or dispositions of property, made by the company to third party creditors would be exempt from the voidable transactions regime. The voidable transactions regime provides that a liquidator can look back at any transactions conducted by a company in the 2 year period prior to liquidation and unwind those transactions if  they believe that a creditor got paid when other creditors didn’t (or got paid proportionately more than others).

Trusts and partnerships will be able to take advantage of the Business Debt Hibernation Scheme but licensed insurers, registered banks and non-bank deposit takers, and sole traders will not. Insolvency of a sole trader is instead subject to the Insolvency Act 2006.

Our view

While we welcome the changes to the insolvency regime which allow directors to continue to allow their companies to trade without fear of future personal liability we are sceptical about how the Business Debt Hibernation Scheme will work in practice.  We question how easy it will be for businesses to get 50% of their creditors to agree to put their debts on hold for 6 months when those businesses may also be struggling. 

For further assistance please contact our Business and Commercial Law team.

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