There were big changes in 2020 in the world of restructuring and insolvency legislation with the introduction of two new restructuring tools: the Moratorium and the Restructuring Plan, as well as the reintroduction of Crown preference.
However, due to the government-imposed moratorium while the pandemic runs its course, we have seen hardly any real effects of those reforms. As restrictions on creditor enforcement action are brought to an end in 2021, we will begin to see how the new measures affect the landscape and what the true fallout will be from the pandemic as well as from the altered economic landscape which Brexit will bring.
Three struggling sectors
Retail will continue to experience the greatest difficulties as consumers have learnt to shop more online since March. We are likely to continue to see retail businesses restructure, reducing their physical presence to only the most profitable locations, while expanding their online offer.
Financial services businesses have been in the news in the past week as the FCA warns of the numbers of them in financial difficulty. No real surprise here. Their customers have not been servicing their loans, protected as they are by the government’s protective measures and thinly veiled pleas to the financial sector to hold off enforcement, reminding the sector of the wide-scale bailouts which it was given in the last downturn. But capital reserves can only last so long and until the economy re-opens properly, it is only a matter of time before we will see the first financial services failures.
The travel industry has clearly taken a big hit in the last 12 months. In fact, the government has been planning to introduce a new special administration regime for airlines since 2019. Though COVID got in the way of those plans, they may see a revival this year.
Crown preference: the waterfall of cause and effect
Crown preference, albeit in a curtailed form, was resurrected in December last year. For insolvency procedures commencing on or after 1 December 2020, HMRC enjoys preferential status for monies deducted or collected by companies on behalf of HMRC (e.g. VAT and employees’ NI contributions). This means HMRC will be paid these sums ahead of floating charge creditors. Apart from the obvious potential shortfall to floating charge holders in existing loans (priced and risk-assessed on a basis which may not have taken this extra cost into account), floating charge holders are likely to alter their approach to new loans to take this extra factor into account, potentially making it more difficult for businesses to access funding. In the short term, borrowing may become more expensive to cover the shortfalls while “old” lending is paid off or refinanced. Refinancing in turn will become more difficult where companies have high outstanding VAT yet to be paid over to HMRC. This will fall into particular focus for all those businesses which have taken advantage of the VAT payment holiday in the last 10 months, whose VAT debt will be high for some time.
CVAs: challenge may lead to a change of direction
Recently, CVAs have focussed on the rental portfolio of businesses to reduce rents and change terms of payment. In turn, challenges have increased as landlords object to being singled out, but so far, with limited success. The trend for challenge will not change over the next twelve months with two important hearings due in March in the Regis and New Look CVAs. There are more in the pipeline. The BPF has also called on the government to consider altering the rules on CVAs to make it harder to compromise the claims of only one class of creditor (namely landlords). If any of these objections begin to gain traction, the market is likely to turn towards the use of one of the new restructuring tools introduced in June, the Restructuring Plan, which is specifically designed to be able to cram down classes of dissenting creditors where their outcome in the resultant plan will be better than under the likely alternative (usually an insolvency procedure like an administration).
Pre-pack scrutiny to increase
In September last year, the government released draft regulations with the aim of imposing statutory scrutiny on pre-pack administration sales to connected parties. Back in 2015 a voluntary regime was initiated in an attempt to dispel the general feeling of discontent among the media with sales of the business and assets of insolvent companies back to their management teams. There was always a threat that if the voluntary regime was underused and/or the noise of discontent did not die down, the government would introduce more stringent measures.
The rise of the cross-class cram-down
There have only been a few examples of companies taking advantage of the new processes introduced last summer to bolster the restructuring arsenal of tools. This lack of take-up is largely because of the moratorium on creditor action which the government has imposed during the pandemic. Once those restrictions are relaxed, however, we are likely to see increased use of new Moratorium process to protect businesses from creditor action while they get restructurings under way.
Equally it may be that as we emerge from the pandemic period and businesses begin to take stock of their financial status, they may consider using the new Restructuring Plan process to compromise their pandemic debt. Why this process rather than a company voluntary arrangement (CVA)? The new process allows more dissenting creditors to be dragged along with the process than a CVA allows. And where we have more struggling businesses, that includes creditors too. Restructuring processes like CVAs which rely on a creditor vote for success may be harder to get through in an economic downturn, leading to an increased reliance on processes with enhanced cram-down ability. In addition, in CVAs, the damoclesian dagger of the post-commencement challenge creates uncertainty for the companies involved as well as the inevitable increase in cost and delay while such challenges are dealt with. Restructuring Plans, once sanctioned by the Court, do not present the same opportunities for disgruntled creditors to raise a post-implementation challenge.
Deal or no deal, there was never a prospect of easy times post-Brexit for the restructuring and insolvency world. It was decided early on that the benefits of EU membership afforded to the R&I market would be lost once the UK exited the EU. Where before we could rely on pan-EU recognition of UK insolvency processes in restructurings which crossed borders, now we will have to apply for recognition in the courts of the individual Member States before a restructuring can proceed; something which will add time, cost and uncertainty to the reorganisation of distressed pan-European businesses.
Baseline insolvencies from 2020 need to be tidied up
The obvious prediction for 2021 is the number of insolvencies which are long overdue which just need to happen. Every year there is a steady number of insolvencies which simply arise as a natural consequence of life. The number is fairly consistent year on year. However last year the numbers of formal insolvencies dropped significantly, and we know it was not because everyone was doing so well. The drop was as a result of the restrictions on creditor enforcement which the government imposed from March. While holding the effects of pandemic-induced shutdown at bay, the moratorium had the wider effect of preventing the natural shedding of failing businesses. Like a growing plant, the economy needs to clear out the dead wood and leaves to thrive. Once it re-opens, it is likely there will be a wave of businesses which were simply hanging on by a thread which will unfortunately have to close.
Whether it be for those dealing with the sheer volume of work or those operating at the cutting edge of the sector, trying out new and innovative ways to use the tools available, it will be a busy year in the restructuring and insolvency end of the market.