2020-09-25
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Practical considerations for exiting lockdown successfully - CWCC Chamber Live Webinar Notes - 24 September 2020

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Posted by Caroline Benfield on 24 September 2020

Caroline Benfield - Insolvency Lawyer
Caroline Benfield Partner

Introduction

Whilst we saw the gradual easing of some of the lockdown measures over the summer and businesses starting to look to the future, over the last couple of weeks or so as the rates of coronavirus infections have increased we have started to see some of the easing of the measures being reversed with the number of people being allowed to meet socially in England being limited to 6, the alert level being increased to four on Monday, on Tuesday people being told to work from home where they can, pubs, bars and restaurants being told to close at 10pm and plans to have spectators at sports venues being paused and we are now waiting for an announcement from the Chancellor on new measures to replace the furlough scheme. At this point in time it is extremely difficult to predict what is going to happen over the coming weeks and months which makes business planning extremely difficult. As businesses are beginning to look to the future, important decisions will have to be made about the size and shape of the business going forward. In many cases accrued rent arrears and government backed loans may have rendered companies balance sheet insolvent and in these circumstances directors must act to protect the interests of creditors.

The statistics show that corporate and personal insolvency numbers are down when compared to the numbers from last year, but this is due to the financial support that has been available to companies and individuals over the last few months and the temporary measures that were brought in to prevent creditors from pursuing their claims through the insolvency courts. However, the pandemic will inevitably affect insolvency levels and we anticipate that we will see an increase in both personal and corporate insolvencies. All the signs point to a tough road ahead and today we are going to give you an overview of the key considerations for directors during this uncertain time. Each of these could form the basis of webinar in its own right but I hope that what follows will provide a useful checklist of some of the most important factors to consider.

What underpins the practical advice that we are going to provide and what is important to understand from the outset is that a director must act in a way which they consider, in good faith, would be most likely to promote the success of a company, for the benefit of the members as a whole. The term “success” generally means an increase in value of the company, but a director needs to decide, in good faith, whether it is appropriate for the company to take a particular course of action and clearly the pandemic adds another dimension to this, not least because it is impossible to predict precisely what impact this will have on business.

When acting in a way they consider would be most likely to promote the success of a company, a director must have regard to a number of issues, which include the likely consequences of any decisions in the long term, the interests of the company’s employees and the need to foster the company’s business relationships with suppliers and customers. However, the list of factors is not exhaustive, and directors should have regard to other matters which are relevant to the duty to promote the success of the company.

1. Financial Reporting, Forecasting and Decision Making

It is essential to create a business plan, cashflow forecast and keep up to date management accounts. You will need these for any negotiations with stakeholders such as landlords, lenders and suppliers to satisfy stakeholders and yourself that the business is viable going forward.

These documents should be reviewed and updated frequently because with regular changes to lockdown restrictions we are in a very fluid situation and businesses need to be agile in dealing with that. If you are going to be asking your landlord to vary the terms of the lease in any way including reducing future rent or writing off arrears, you are going to need to be able to demonstrate why this is necessary.

It is also essential that the board works together against a clear plan. Regular board meetings should be held and all decisions and the reasoning behind them need to be carefully documented including any dissent and the reasons for this.

You should record all sources of information that may not be available in the future, taking a screen shot where printing may not be an option. This is because if the business fails for any reason, the liquidator or administrator is under an obligation to conduct an investigation into the causes of the company’s failure and the conduct of the directors. In the context of such an investigation the directors may need to justify any decisions that they took and decisions can be easily justified if contemporaneous notes and records are taken and kept.

If the insolvency office holder is critical of the conduct of the directors and the directors are unable to justify the actions they took, they could face proceedings for misfeasance or breach of duty by causing loss to the company. Relief from liability might be available if a director is able to demonstrate that he acted honestly and reasonably and the circumstances of the case mean that it is fair to excuse him from liability. It is going to be a lot easier to demonstrate that you acted honestly and reasonably if you can provide contemporaneous evidence of your decision making process and documentation showing why you took the steps you did at that time and why you believed you were acting in the best interests of the company at that time.

2. Rent and Dealing with Landlords

Currently, forfeiture of leases by way of legal proceedings or peaceable re-entry due to non-payment of rent is prohibited under the Coronavirus Act 2020 until 31 December 2020.  Whilst this moratorium is in place, a landlord will not be able to evict a tenant for non-payment of rent. However, it doesn’t stop rent being payable and once the legislation has lapsed, a landlord will be able to claim for forfeiture for both payments that became due during the moratorium period and for any rent becoming due but unpaid after it ends.

In addition to the above, all possession proceedings are now stayed until 31 December 2020. This means that existing proceedings for possession cannot currently be restored. Once the moratorium lapses there  is a new procedure to follow which requires the landlord to serve a “re-activation notice” which must include details of what effect the coronavirus has had on the defendants and their dependents and where the claim is based on arrears of rent, the claimant landlord must provide a rent account for the previous two year period.

In addition to the moratorium on forfeiture, the limitations on the use of Commercial Rent Arrears Recovery (CRAR) have also been extended to 31 December 2020.  The Taking Control of Goods and Certification of Enforcement Agents (Amendment) (Coronavirus) Regulations 2020 were introduced in the spring and prevented landlords from using CRAR unless an amount of at least 90 days’ rent was due (it had previously been seven days or more). From 24 June 2020, this was increased to at least 189 days' rent under the Taking Control of Goods and Certification of Enforcement Agents (Amendment) (No. 2) (Coronavirus) Regulations 2020 and from 16 September 2020 the requirement is 276 days’ outstanding rent, rising to 366 days for enforcement notices given after 24 December 2020).  

Where rent has not been paid during lockdown, you should take steps to negotiate with the landlord regarding the timing and payment of any arrears and future rent.  Consider the pros and cons of a further deferral of rent leading to a debt on the balance sheet, versus the cashflow implications of monthly/quarterly payments.  Consider asking the landlord to apply the rent deposit against any arrears without seeking a top up.  

It is important to remember that the Landlord is unlikely to want the premises back at this point and this puts you as a tenant in a relatively strong bargaining position. However, engaging with your landlord is important to avoid action being taken once the moratorium/stays are lifted and as I’ve have mentioned above, a landlord will likely want financial information and forecasting from the tenant in order to assess and evaluate proposals.

3. Contracts with Suppliers and Customers

Cash is king so all outgoings should be minimised and contracts with suppliers and customers should be reviewed. Where possible you should seek to shorten customer payment terms and internal (credit control) systems should be put in place to ensure that these are adhered to. This will require someone in your organisation to act as credit controller with the necessary systems in place to ensure that action is taken quickly if payment terms are not adhered to and credit terms are not extended beyond those contained in contract.

Whilst you can consider extending supplier payment terms the danger here is that you will start to incur debt on your balance sheet that the business cannot subsequently discharge. As such you need to carefully consider whether extending supplier payment terms is going to lead to the business becoming insolvent on a balance sheet basis, meaning that liabilities exceed assets. This will have a bearing on the duties of the directors and also emphasises the point I made earlier about the importance of having an accurate cashflow forecast and management accounts.

On 25 June 2020 the Corporate Insolvency and Governance Act 2020 received royal assent and came into effect on 26 June 2020. Amongst other things, it introduces a disapplication of the rights of a supplier to terminate a contract as a result of the company’s insolvency. Many commercial contracts for the supply of goods and services contain clauses (often referred to as ipso facto clauses) to allow termination of the contract in the event that a party enters into any insolvency proceedings, or sometimes even if such action is threatened. Typcially a supplier would refuse to continue supplying the other party in an insolvency situation and would often use the clause as leverage to try and obtain payment of previous debts.

There had been increasing concerns raised that these clauses prevent those in financial difficulty from engaging in any meaningful insolvency procedure as the contract would simply be terminated in such an event. The policy intention behind the new provisions was therefore to help companies trade through a restructuring or insolvency procedure, and to maximise the opportunity for rescue of the company or the sale of the business as a going concern.

The law already provided some protection for insolvent companies against certain suppliers who provide essential goods and services (e.g. utilities), but the Act broadens the scope of these restrictions to a wider range of suppliers.

The new provisions under the Act apply where a company becomes subject to a relevant insolvency procedure which includes such things as Administration and Liquidation and they state that a provision in a contract for the supply of goods or services ceases to have effect when a company becomes subject to an insolvency procedure if under the provision:

  1. the contract or the supply would terminate because the company becomes subject to the insolvency procedure, or
  2. the supplier would be entitled to terminate the contract or the supply, or do any other thing, because the company becomes subject to the insolvency procedure.

This effectively means that there is a prohibition on the reliance by suppliers of termination clauses in contracts for the supply of goods or services that are triggered when a party has entered into a formal insolvency procedure.

The wording “any other thing” is not defined. The wording is broad and captures the exercise of any contractual right triggered upon an event of insolvency. There is also the potential that it could include action taken pursuant to ROT provisions.

The provisions also mean that where under a provision of a contract for the supply of goods or services the supplier is entitled to terminate the contract or the supply because of an event occurring before the start of the insolvency period and the entitlement arose before the start of the insolvency period, the entitlement may not be exercised during the insolvency period.

However, for new breaches which happen after the insolvency procedure begins, suppliers will still be allowed to terminate.

Further, a supplier will be able to terminate a contract if the company or officeholder consents or if the Court is satisfied that the continuation of supply would cause the company hardship. However, “hardship” is not defined in the Act and will undoubtedly need to be resolved the Courts.

What is also built in is provision restricting a supplier from requiring pre-insolvency debts to be paid as a condition of making further supplies.

The new provisions apply where the insolvency procedure commences on or after 26 June 2020 and they will apply in respect of contracts entered into before as well as after that date.

There is also currently a temporary exclusion for small suppliers (who are determined as being “small” based on turnover, balance sheet and number of employees) who have supplied to a company that has gone into a formal insolvency process between 26 June 2020 and 30 September 2020.

The temporary exclusion was likely designed to soften the impact for small businesses in the short term, but once the relevant period has expired (subject to any extension on that time period) it may apply to all suppliers. It will therefore be important that they manage their credit control processes carefully so that they don’t accrue bad debt.

It remains to be seen how these provisions will work in practice and how some of the less precise terms will be interpreted by the Courts. However, given that the Courts’ resources are being stretched and tested may dissuade suppliers from applying to court for permission for their contracts to be terminated under the hardship exemption perhaps leaving them to try and reach consensual arrangements with the company or officeholders.

4. Practical considerations for Contracts – both existing and new

to recap:

  • any provision in a supply contract that provides for automatic termination, or which allows the supplier to terminate, based on the customer’s insolvency, ceases to have effect. This prevents a supplier from exercising an insolvency termination right and also from relying upon any provision as to automatic termination;
  • any other consequence that is triggered by such insolvency (for example, a right to refuse to continue to supply or a right vary the terms pursuant to which ongoing supplies will be made) also ceases to have effect;
  • A supplier cannot rely upon a provision that would have allowed them to terminate because of an event occurring before the company entered into insolvency, where the entitlement arose but was not exercised before the commencement of the insolvency proceedings;
  • A supplier cannot make it a condition of continuing to supply that any outstanding payments are paid, or do anything that has this effect. It does not mean that the customer does not continue to owe the amounts outstanding under the supply contract, but the supplier cannot make payment a condition of continuing to supply..

As outlined earlier, suppliers can still terminate in some restricted circumstances and can also take the following steps in relation to existing contracts AFTER the formal insolvency procedure has started:

  • Wait for new contract termination right to arise; for example, non-payment for supplies made after the commencement of the insolvency.
  • Exercise contractual rights to terminate for convenience. It is not clear yet whether section 233B would prevent a supplier from exercising a right to terminate for convenience (the concern being that a pre-existing right to terminate for convenience could be considered to be an “event occurring before the start of the insolvency period”). On balance, we consider that section 233B should not prevent a supplier from giving notice to terminate for convenience (provided it is a genuine right to terminate for convenience) after insolvency proceedings begin, as long as supplies continue to be made during the notice period.
  • Invoke other rights. Exercise any other contractual rights (for example, any contractual set-off and netting rights, although in some cases, these rights may be superseded by the application of mandatory insolvency set-off rules).
  • Reject new customer orders. A supplier could decline to provide further supplies where the existing contract is a single-purchase order. It may be possible to achieve a similar result with a contract which is structured as a framework agreement, where each new customer order constitutes a separate contract with the supplier free to decline such orders.
  • Refuse to renew an existing contract once expired.
  • Negotiate with the insolvency office-holder.

What should be considered for new contracts?

  • Reduce the contract term. A short contract term will ensure that the supplier will not be locked into supplying the customer for a considerable period in any insolvency procedure. Of course, this needs to be balanced against the commercial objective of securing a customer for as long as possible.
  • Structure the contract as a series of separate contracts. The supplier could structure its supplies under a framework agreement which provides that each supply is treated as a separate contract that the supplier is free to accept or decline.
  • Tighten the payment structure. Tighter payment terms may provide earlier warning signs of the customer experiencing financial problems.
  • Include retention of title provisions. If supplying goods, consider including retention of title provisions which are capable of being exercised prior to an insolvent event arising (a supplier’s ability to enforce is affected if the customer enters administration or becomes subject to a Part A1 moratorium).
  • Impose financial information reporting obligations on the customer. The supplier could require the customer to provide regular financial information to enable the supplier to assess its continued solvency. Information to be provided could include:
    a. Information relating to the customer’s financial status, such as its credit rating.
    b. Regular reports on the customer’s current and recent performance.

This could be linked to a right to terminate for financial distress (prior to the occurrence of an insolvency event).

  • Suspend further supplies for non-payment. As an interim step falling short of termination, a supplier could consider including a provision allowing it to suspend further supplies under the contract for repeated or lengthy periods of non-payment by the customer. Once the customer enters insolvency proceedings, section 233B may require the customer to restart supply, but the suspension may have helped manage the size of the outstanding payments.
  • Allow termination for convenience. Ensure that the supplier can terminate for convenience and include as short a notice period as makes commercial sense.

Practical steps

On a practical level, a supplier may wish to consider the following steps:

  • Conducting deeper due diligence on customers’ financial position before entering into contracts and actively monitoring customers’ payment performance and financial position during the contract to get earlier warning of likely difficulties.
  • Providing training to employees who manage contracts on the impact of the changes set out above.
  • Ensuring that it has a good working knowledge of at least its key customer contracts, so that it is familiar with its rights if a customer shows sign of financial trouble and is able to exercise them promptly.
  • Ensuring that invoices are paid when due and (if necessary) tightening debt collection procedures.
  • Exploring invoice finance options and/or obtaining trade credit insurance, if available.
  • Being ready to promptly exercise contractual rights to stop supply or terminate the contract promptly if a customer starts showing clear signs of financial distress.
  • Reviewing standard terms and conditions to make sure they still protect the supplier against a customer’s insolvency, as far as possible.

5. Employees and Furlough

Consider carefully future staffing requirements. Realistically the business is likely to have a reduced turnover and may not require all its existing staff so the sooner redundancy consultation begins the sooner the business can move forward in a slimmed down form.

[It was announced yesterday that the Chancellor is due to announce new job protection measures today. There has been speculation about what this might entail but we will have to await the detail later today]

Consider whether you have operated the furlough scheme correctly or whether you are no longer entitled to keep the CJRS grant because circumstances have changed (e.g. you continued to receive a CJRS grant for an employee after they left employment. Businesses who have received the grants when they were not entitled to must self-report to HMRC and pay back the sums incorrectly received within the 90 day reporting window. This is the later of:

  • 90 days after receipt of the CJRS grant or
  • 20 October 2020

Self-reporting will protect a business from financial penalties that HMRC may impose. If a business fails to self-report within the 90-day window, they will be liable to a penalty on the basis that the wrongdoing was deliberate and concealed. The penalty range is a minimum of 30%, up to a maximum of 100% of the sums received.

However, in cases where HMRC can prove a business intended to commit fraud, it will consider criminal charges and in these circumstances, self-reporting would not protect a business from these sanctions.

In circumstances where business has become insolvent and the tax cannot be recovered, sanctions may be imposed on any of the directors personally who knew of the CJRS grant.

6. Crown Debt

Avoid using accrued crown debt as working capital. Whilst HMRC temporarily deferred payment of VAT and extended “time to pay” arrangements, this position will not last forever. The VAT deferral scheme came to an end on 30 June 2020 and this means that from that date all VAT returns need to be submitted on time and VAT paid as and when it falls due after 30 June 2020. All deferred VAT needs to be paid in full on or before 31 March 2021 and this will need to be factored in to your cashflow forecast. Extensions to time to pay arrangements will be dealt with on a case by case basis but you will need to make provision in your cashflow forecast for payments to resume.

The business bates holiday for businesses in the retail, leisure and hospitality sectors only extends to March 2021 so your cashflow forecast will need to make provision for payment of business rates after that period.

7. Temporary measures contained in CIGA 2020

As explained above, the CIGA 2020 came into force on 26 June 2020. This also introduced a number of temporary measures designed to mitigate the effects of the coronavirus on businesses. One of those measures was that it became impossible to present a winding up petition based upon non-compliance with a statutory demand served between 1 March 2020 and 30 September 2020. A winding up petition cannot be presented upon any ground between 27th April 2020 and 30 September 2020 unless it satisfies the new coronavirus test. This means that the creditor has to satisfy the court that the reason the debtor cannot pay the outstanding debt has nothing to do with the effects of the coronavirus. This measure is double edged depending upon whether you are a creditor or debtor. From a debtor’s perspective it is clearly positive because a judge will simply dismiss the petition if he or she believes on the evidence that the debtor’s inability to pay is coronavirus related. However, from a creditor’s perspective the threat of winding up proceedings as a tool to extract payment of an overdue debt has been removed. This prohibition on winding up proceedings is temporary and is currently due to expire on 30 September 2020 but the legislation has built into it the ability for the expiry date to be extended so it could be extended at short notice. We anticipate that it will be ended to the end of the year in line with the extension on the moratorium of forfeiture of commercial leases, but an announcement has yet to be made.

The Act included another temporary measure designed to mitigate the effects of coronavirus, namely a suspension of the wrongful trading provisions in the Insolvency Act 1986. A claim for wrongful trading arises where a company goes into insolvent liquidation and the liquidator forms the view that the company ought to have ceased trading at an earlier point in time. If the company’s balance sheet position deteriorated between the point it actually ceased trading and the point at which the liquidator believes it ought to have ceased trading, he can seek a contribution from the directors towards the increased deficit. However, the CIGA 2020 introduced a temporary suspension of the wrongful trading provisions such that a director cannot now face liability for wrongful trading arising from any conduct which took place between 1st March 2020 and 30 September 2020. As before it is possible for that date to be extended.

However, it is important to emphasise that all other directors’ duties under the Companies Act 2006 remain in place and these include acting within your powers, exercising independent judgment, promoting the success of the company, exercising reasonable care, skill and diligence and avoiding conflicts of interest. However, if at any point you have reason to believe that the company is insolvent on a cashflow or balance sheet basis, advice should be sought from an insolvency professional at the earliest opportunity. Taking and acting upon such advice will assist in deflecting any accusation that you failed to act in the interests of the company’s creditors.

It may be possible to put together a restructuring plan or a company voluntary arrangement if the business is thought to be viable going forward. The CIGA 2020 has introduced a new Moratorium process for businesses in this position. This provides an initial breathing space of 20 days (which can be extended) during which no enforcement action can be taken against the company whilst it explores a range of rescue options.

Close

It is extremely difficult to predict how this is all going to play out given that the landscape is forever changing, but we hope that the guidance we have provided during this webinar has been useful in providing an overview of some of the key consideration for directors and business owners during this difficult time.

About the author

Caroline advises on all aspects of contentious and non-contentious personal and corporate insolvency matters.

Caroline Benfield

Caroline advises on all aspects of contentious and non-contentious personal and corporate insolvency matters.

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