Caroline Benfield and Elizabeth Taylor from our insolvency team discuss the measures to assist business trade through Covid-19 pandemic
Clay. Over the last week or so, the government has announced a range of measures to assist business trade through Covid-19 pandemic. Can you run through the most significant of these?
ET. In the first days after the lockdown was announced many businesses, particularly in the retail and hospitality sectors, experienced a catastrophic fall in turnover. We received a number of enquiries from directors on what steps they should be taking in light of this both in terms of protecting their business and their own personal position as directors.
Under existing insolvency legislation, for example, directors can be found liable to contribute to the assets of an insolvency company of they are found liable for wrongful trading?
Clay. Can you just explain what wrongful trading is and how personal liability can arise
ET. Wrongful trading arises where a director knew or ought to have known that a company cannot avoid insolvency liquidation.
(This is not the same as realising the company is insolvent as the directors might have a plan to get back on track). If down the line the company goes into liquidation or administration the liquidator or administrator will compare the balance sheet deficit at the date of formal insolvency with the position as at the date he believes the company ought to have ceased trading and apply to the court for an order that the directors compensate the company for a sum equivalent to the difference.
Clay. So, what has the government done to remove this risk?
ET. The government has suspended the wrongful trading provisions with effect from 1 March 2020, and this means that directors will not face personal liability for wrongful trading because of the decisions that they make with regard to trading the company from that point onwards.
CKB. Directors will need to be mindful of the fact that the proposed suspension of the law on wrongful trading will not affect directors’ other ongoing duties, such as all of the duties under the Companies Act and those other checks and balances to ensure property conduct are expected to continue. The changes should not be seen as an opportunity for directors to turn a blind eye to their obligations, but to prevent otherwise viable businesses during this challenging and uncertain time.
Clay. Many businesses, particularly in the retail sector, were struggling before COVID-19.
ET. That’s right, and it remains to be seen whether the measures that have not been introduced will be enough to save them. We have already seen the demise of Brighthouse, Carluccio’s, Cath Kidston, for example, all of which have gone into administration.
Carluccio’s was already in a CVA and had experienced a reduction in trade due to the downturn in casual dining, and the lockdown was simply the last nail in the coffin for them. Debenhams is about to go into administration for the second time this week; it was already in a CVA, but reports suggest that it will be a very light touch administration to prevent creditors taking any enforcement action with the business continuing to trade under the management of the existing directors who would be very unusual but perhaps a model we’ll see again in these extraordinary times.
CKB. HMRC have also announced a range of measures designed to assist business at this time. The first of these is to offer a deferral of VAT payments owed between 20/3/20 and 30/6/20 to help businesses manage their cash flow. They will not charge interest or penalties on any amount deferred as a result of the chancellor’s announcements. However, businesses need to note that they will still need to submit their VAT return on time and if they choose to defer VAT as a result of coronavirus, they must pay the VAT due on or before 31/3/21.
The second measure relating to individuals, companies and partnerships that are already in a voluntary arrangement is where HMRC recognises that further guidance may be needed where either contribution cannot be made or post arrangements tax obligations cannot be met as a result of the impact of coronavirus. Where the terms of an arrangement allow the supervisor discretion, HMRC expects that discretion to be exercised to its maximum with reference to creditors only if essential. HMRC will support a minimum three months break from contributions from customers impacted by coronavirus, and there is no need to contact HMRC to request this deferment.
The third measure is that HMRC has paused the majority of insolvency activity for now. That means HMRC will not petition for bankruptcy or winding-up orders unless it is deemed to be essential, i.e. fraud or criminal activity.
Clay. The secretary of state has announced a range of other changes to insolvency legislation to assist struggling businesses. What do these involve?
ET. The government announced a raft of changes at long ago as 2016 as part of its review into the corporate insolvency framework. These have been subject to consultation, and in August 2018 the government published its response. Effectively what Alok Sharma has announced is that some of these changes are going to be fast-tracked. Until we see the legislation, we cannot be certain what it will say.
Still, the indications are that they will include a moratorium procedure for businesses to prevent creditor action and provide a breathing space for businesses to seek advice on the best course of action. Currently, a moratorium can only be sought in company CVAs where the turnover is less than £5.7 or where the company goes into administration.
CKB. The new moratorium is expected to last for an initial 28 days, it can be extended for an additional 28 days if various conditions are met and beyond that, it can only be extended if over 50% by value of secured and unsecured creditors agree. The moratorium is only going to be available to businesses that are not yet insolvent and so can pay their ongoing liabilities during the moratorium period. These measures are likely to provide a vital breathing space for a business that were healthy and viable before the Coronavirus pandemic and hope to return to that position provided creditor action can be held at bay. As part of the reforms, the existing moratorium procedure for small company CVAs will be abolished.
ET. Interestingly in the original government proposals, the company’s entry into a moratorium would not of itself provide any protection against a wrongful trading claim, and there are expected to be sanctions against directors for abusing the moratorium process. I would expect the original proposals to be amended in the new draft legislation to reflect the changes to wrongful trading law which we’ve already discussed. Still, we’ll have to wait and see because the wrongful trading changes were obviously not envisaged when the moratorium was originally conceived.
CKB. The new legislation will also include a prohibition on enforcement of contractual termination clauses in contracts for the supply of goods or services. Such clauses are typically drafted to allow one party to a contract the right to terminate if the other party enters a formal insolvency process.
The prohibition will apply in the event of a formal insolvency, the pre-insolvency moratorium we’ve just been discussing and the new restructuring plan process we’ll come on to. If a supplier creditor feels that the viability of their own business is adversely affected by the prohibition, they are entitled to apply to the court for an order that they be exempt from the prohibition. The prospect of the supplier’s insolvency is likely to be seen by the court as grounds for exemption.
ET. A new standalone restructuring process is also going to be introduced. It is a little like the existing scheme of arrangement that has to be sanctioned by the court. It will be available to solvent and insolvent companies. A proposal will be sent to creditors, shareholders and filed at court.
There will be a hearing, and in the first instance, the court will decide whether to convene meetings of the various classes of stakeholders to vote on the proposals. If the various stakeholders approve the proposals, only then will the court decide whether to sanction the scheme. Creditors and shareholders can suggest counter proposals subject to the court’s agreement.
In terms of voting majorities, assuming that the new legislation follows the 2016 proposals, they will have to be approved by over 75% by value of each class of creditor and over 50% of all unconnected creditors (like existing CVAs). The court will have powers to approve the plan even where one class of creditor votes against it if satisfied that the plan is in the interests of creditors as a whole and the dissenting creditors are no worse off then they would be in the event of the next best alternative, which may well be a formal insolvency process.
In these circumstances, the court can require the claims of dissenting creditors to be paid in full before any dividend is paid to any class of creditor who ranks lower in the prescribed order of priority under insolvency legislation. Alternatively, in certain circumstances, the court can sanction the scheme even if this is not the case, so the court has wide powers here.
CKB. It remains to be seen whether the wording of the new legislation when published mirrors exactly the 2016 proposals and what we don’t yet know is how quickly this legislation can pass through parliament.
Given the speed at which the Coronavirus Act 2020 was enacted it may well come into force within a couple of weeks of parliament returning from the Easter recess and as such it seems unlikely that there will be any material changes to the proposals. Given that a large number of business are struggling to access the government’s financial rescue packages, it is looking increasingly likely that there will be a pressing need for these measures in the coming weeks and months.
Clay. Remind me what the rescue packages were.
ET. There are a vast number of measures now in place, far too many to cover here. The main ones and the ones which were intended to provide immediate cash for businesses are the Coronavirus Business Interruption Schemes and the Retail and Hospitality Grant Scheme.
CKB. The Coronavirus Business Interruption Loan Scheme is supported by 40 accredited lenders who will provide SMEs with loans, overdraft facilities, invoice finance and asset finance of up to £5m for up to 6 years. To be eligible, the business must have an annual turnover of no more than £45m. The government will pay the interest for the first 12 months together with any lender fees, and the government will provide a guarantee to the lender of 80% of the advance.
Following concerns raised by MPs, banks and small businesses, the Treasury has overhauled how its Coronavirus Business Interruption Loan Scheme will operate to make it easier to access. Now all viable small businesses affected by Covid-9, and not just those unable to secure regular commercial financing will be eligible should they need to finance to keep operating during this difficult time. The Treasury has also dropped requirements for lenders to operate the scheme under normal lending protocols which meant they often asked for security such as a personal guarantee or a charge over a property for smaller loans.
However, this will continue for loans of more than £250,000 which means that lenders can ask directors to provide a PG for the remaining 20% if this exceeds £250,000 and this has proved to be a deterrent for many and seems to contradict the spirit of what the government was trying to achieve.
Alok Sharma made it clear that the taxpayer bailed the banks out in the financial crisis of 2008 and as such, he expected the banks to reciprocate now so time will tell.
ET. There is also the Coronavirus Large Business Interruption Loan Scheme. This is a government-backed scheme to enable lenders to provide loans of up to £25million to businesses with a turnover of £45-500m. Again, the government will guarantee 80% of the loan and further details of this scheme will be announced later this month.
CKB. It is, however, important to emphasise that it is a condition of eligibility for both schemes that the business must have been viable and have borrowing capacity but for the pandemic.
ET. For smaller businesses in the areas of retail, hospitality and leisure, the Retail and Hospitality Grant Scheme will provide a cash grant of £25,000 per property for those businesses with property with a rateable value of between 15k and 51k.
For those businesses with a rateable value of less than £15k, a cash grant of £10k is available. These schemes are operated by local authorities so if you fall into one of these categories you may have been contacted directly by your local authority.
If you haven’t been this might be because your local authority is operating an applications process so details should be available on the local authority web site.
CKB. Full details of all the assistance packages are available online at.gov.uk/coronavirus
ET. Yes, and it is important to check the information provided there on a regular basis as it is being updated. Many of the measures introduced will undoubtedly have teething problems that will have to be ironed out over time.