This country-specific Q&A provides an overview to restructuring and insolvency laws and regulations that may occur in the United Kingdom.
This Q&A is part of the global guide to Restructuring & Insolvency (3rd edition). For a full list of jurisdictional Q&As visit http://www.inhouselawyer.co.uk/practice-areas/restructuring-and-insolvency-3rd-edition/
What forms of security can be granted over immovable and movable property? What formalities are required and what is the impact if such formalities are not complied with?
The type of security granted over an asset in England and Wales largely depends on whether legal title (i.e. ownership in the ordinary sense) to the secured asset is intended to be transferred to the secured party. Security can be in the form of a mortgage or security assignment (transfer of title, security provider retains possession) or a charge (no transfer of title, security provider retains possession). There are also other types of security which apply where the secured party is in possession of the secured asset, e.g. liens and pledges.
To create a mortgage, the legal or beneficial title to the secured asset must be transferred to the security-holder. Mortgages are most commonly granted over real estate, but are also seen in movable property such as ships and airplanes. Legal mortgages must be in writing and executed as a deed by the security provider (the mortgagor). To take effect as a legal mortgage, a mortgage over registered title must be registered at the Land Registry. If the security is not registered, it will usually take effect as an equitable mortgage, which can undermine the strength of the security in the case of competing claims.
A charge may be either “fixed” or “floating”; secured lenders will usually aim to ensure that as much of their security is fixed as possible. A fixed charge requires the security provider (the chargor) to hold the charged asset (e.g. shares) to the order of the secured party (the chargee); while a floating charge permits the chargor to deal with the asset in the ordinary course of business (the floating charge hovers above a shifting pool of assets such as cash, stock and inventory). Charges are easier to grant than legal mortgages as there are fewer formalities involved. Charges must be in writing and signed by the security provider.
Security granted by an English company or LLP must be registered at Companies House within 21 days of creation or it may be void on insolvency and against third parties. Other types of security, e.g. over intellectual property, require further formalities; certain mortgages and charges over interests in land must be executed as a deed.
What practical issues do secured creditors face in enforcing their security (e.g. timing issues, requirement for court involvement)?
Enforcement options depend on the nature of the security and the provisions of the security document, amongst other matters.
Receivership: A secured creditor may enforce its security by appointing a receiver (usually an insolvency practitioner) over the specific secured asset(s), in accordance with the terms of the security document. The appointment can be made without court involvement. Following the appointment, the receiver will have broad powers specified in the security document, including to collect in any income from the asset and to sell it. (Administrative receivership - which involves the appointment of an insolvency practitioner over the whole of the company’s property - is now available in only limited circumstances.)
Power of sale: A creditor may also exercise its power of sale under the security document (if they have a legal mortgage or if the terms of the security document otherwise permit). This permits the creditor to sell the secured asset, without needing to apply to court, and use the proceeds to settle the secured liabilities. A receiver or a creditor selling secured assets is obliged to get the best price reasonably obtainable in the circumstances; no public auction is required unless required by the security document. One advantage of appointing a receiver is that the lender is not usually responsible for the receiver's conduct.
Administration: If a creditor has security over all or substantially all of the company's assets (including a floating charge), the creditor would usually have a “qualifying floating charge” (or QFC). Once their security becomes enforceable, a QFC holder may appoint an administrator (a licensed insolvency practitioner) over the company quickly and easily without going to court. This is a popular enforcement option as it creates a moratorium on other enforcement action against the company (see also Question 7.) and potentially allows a sale of the business as a going concern, thereby maximising value.
Appropriation: Where the security constitutes a “financial collateral arrangement”, under the Financial Collateral Arrangements (No. 2) Regulations 2003, the enforcement option of appropriation is available. “Financial collateral” includes cash and financial instruments (including shares); the security arrangement must constitute the requisite degree of “possession or control” to qualify as a “financial collateral arrangement”. The remedy of appropriation permits the secured creditor to appropriate (essentially, take possession of) the financial collateral, without applying to court. The power depends on the terms of the security document. If the value of the financial collateral appropriated exceeds the secured debt, the secured creditor must account to the security provider for the excess.
Foreclosure: In theory, the possibility of foreclosure constitutes an additional enforcement option, but this is uncommon in practice for various reasons.
What is the test for insolvency? Is there any obligation on directors or officers of the debtor to open insolvency procedures upon the debtor becoming distressed or insolvent? Are there any consequences for failure to do so?
“Insolvency” is not expressly defined under English law but can generally be demonstrated if (1) a debtor is unable to pay its debts as they fall due (the “cash flow” test); or (2) its liabilities (including contingent and prospective liabilities) exceed its assets (the “balance sheet” test). A company will also be insolvent if it fails to comply with a statutory demand for a debt of over £750 or it fails to satisfy enforcement of a judgment debt.
There is no obligation on directors to commence insolvency proceedings when a company is insolvent. However, directors may be personally liable if they breach certain duties, as set out in Question 14 below. For example, directors can be liable for wrongful trading if they knew or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation or administration and, from that point, failed to take every step to minimise potential losses to creditors. There are also potential criminal sanctions for fraudulent trading (which includes where the business was carried on with the intent to defraud creditors).
The insolvency tests are used to establish whether:
- there are grounds for the company to enter liquidation or administration;
- a company was “insolvent” for the purpose of antecedent transaction claims subsequently brought by an insolvency officeholder; and
- there has been an event of default under the company’s finance documents.
What insolvency procedures are available in the jurisdiction? Does management continue to operate the business and / or is the debtor subject to supervision? What roles do the court and other stakeholders play? How long does the process usually take to complete?
The key insolvency procedures are administration, liquidation (also known as winding up) and company voluntary arrangement. Outside formal insolvency proceedings, schemes of arrangement have also been used to effect restructurings - see Question 8.
Administration: This is the key insolvency procedure with a view to company rescue. Similar to the U.S. Chapter 11 regime, a company that files for administration has the protection of a statutory moratorium to allow it to be rescued or reorganised or its assets realised. However, unlike in Chapter 11, management lose control of the company to an administrator (who is a licensed insolvency practitioner and an officer of the court). The administrator will seek to rescue the company as going concern in the first instance, but if that is not possible, the goal of the administration is to achieve a better result for creditors than in a liquidation (or, failing that, a realisation of the company’s assets). The administrator’s duties are owed to the creditors as a whole. If the administration has not come to an end within a year, the administration will end automatically unless its term is extended in advance.
“Pre-pack” administrations are particularly prevalent in the UK: an arrangement under which the sale of all or part of the company’s business or assets is negotiated with a purchaser (by putative administrators) prior to the appointment of administrations. The administrators effect the sale almost immediately after appointment, without the sanction of the court or creditors.
Liquidation: This is a dissolution procedure involving the termination of the company (and, ultimately, its removal from the register). It involves the appointment of liquidators who collect and sell the company’s assets and distribute the proceeds to creditors (and members, in the unlikely event of a surplus); directors lose control.
Company voluntary arrangement: This insolvency procedure permits a company to make a binding compromise with its creditors. A CVA cannot compromise secured creditors without their consent. A CVA is implemented out of court unless it is challenged. A CVA requires the consent of at least 75% in value of unsecured creditors; the CVA will not be approved if more than half of the total value of unconnected creditors vote against the CVA. In recent years, CVAs have been used extensively to compromise companies’ leasehold obligations to landlords, especially in the retail and casual dining sector.
Special regimes apply for certain types of companies such as financial institutions, certain regulated entities and charities.
How do creditors and other stakeholders rank on an insolvency of a debtor? Do any stakeholders enjoy particular priority (e.g. employees, pension liabilities)? Could the claims of any class of creditor be subordinated (e.g. equitable subordination)?
On the insolvency of a debtor, proceeds from the realisation of assets must be distributed by an insolvency practitioner, in simple terms, as follows: fixed charge holders; expenses in the insolvency proceedings; preferential creditors; prescribed part creditors; floating charge holders; unsecured provable debts; statutory interest on provable debts; unprovable debts (a debt of the company which is not technically provable but which is required to be paid before shareholders are entitled to a return of capital); subordinated claims (where appropriately worded); and finally, shareholders.
Preferential creditors include certain (limited) employee remuneration claims. In addition, a “prescribed part” is carved out of the proceeds of floating charge realizations, which is made available to satisfy unsecured debts, up to a cap of £600,000.
The Government plans reforms to the preferential creditor regime, to make the UK tax authority, HMRC, a “secondary preferential creditor” for certain tax debts, including VAT and PAYE, from April 2020. It also plans to increase the maximum cap for the prescribed part from £600,000 to £800,000.
There is no concept of equitable subordination in England and Wales.
Can a debtor’s pre-insolvency transactions be challenged? If so, by whom, when and on what grounds? What is the effect of a successful challenge and how are the rights of third parties impacted?
Certain pre-insolvency transactions may be challenged under the Insolvency Act 1986.
Possible grounds for challenge include transactions at an undervalue, preferences, extortionate credit transactions, avoidance of floating charges, transactions defrauding creditors and property dispositions after the commencement of a winding up. Each of these grounds essentially aims to unwind transactions that would otherwise have frustrated or otherwise allowed the company to avoid the payment of creditors on insolvency in accordance with the statutory priority of claims. In most cases, only an administrator or liquidator of a company may bring a claim challenging a reviewable transaction (although claims for transactions at an undervalue and preferences can now been assigned by the officeholder to any third party). However, where there is fraud, any party that is a victim of the transaction may make a challenge.
The look-back period ranges between two years prior to the commencement of insolvency proceedings where the transaction was with a connected party (including directors, shadow directors, and associated persons and companies) to six months for other parties.
The court generally has a wide discretion to make any order it thinks fit for restoring the position to what it would have been but for the relevant antecedent transaction. There are protections for third parties who acted in good faith, for value and without notice of the relevant circumstances.
What form of stay or moratorium applies in insolvency proceedings against the continuation of legal proceedings or the enforcement of creditors’ claims? Does that stay or moratorium have extraterritorial effect? In what circumstances may creditors benefit from any exceptions to such stay or moratorium?
The widest form of moratorium is offered by administration. The moratorium prohibits any steps/actions from being commenced or continued against the company and its property, except with the administrator’s consent or the permission of the court. This includes preventing any secured creditor from enforcing its security interest (unless the security constitutes a financial collateral arrangement - see Question 2. above regarding the remedy of appropriation, which is exempt from the moratorium in administration).
In a compulsory liquidation, no action or proceedings can be continued or raised except with the leave of the court. Creditors may however take steps to enforce their security or repossess assets which are not actually owned by the company (such as goods subject to a retention of title clause). In a voluntary liquidation, there is no moratorium on legal proceedings against the company.
A company voluntary arrangement (CVA) can also offer a (non-automatic) moratorium for small eligible companies (i.e. which satisfy two or more of the following criteria: (i) turnover not more than £10.2m, (ii) balance sheet total not more than £5.1m and (iii) not more than 50 employees). A scheme of arrangement (unless combined with an administration) does not offer a moratorium.
Unlike in the U.S., a moratorium under English law does not purport to have extraterritorial effect. Its recognition under the laws of another jurisdiction will depend on applicable national law. For example, EU Member States that are signatories to the Recast EU Insolvency Regulation will recognize the UK proceeding (including by recognizing the related moratorium in the relevant Member State) where the debtor’s CoMI is in, or such debtor has an establishment in, the UK (although see Question 21. regarding recognition post-Brexit).
What restructuring and rescue procedures are available in the jurisdiction, what are the entry requirements and how is a restructuring plan approved and implemented? Does management continue to operate the business and / or is the debtor subject to supervision? What roles do the court and other stakeholders play?
In addition to administration and company voluntary arrangements, discussed at Question 4. above (insolvency proceedings which can also be considered restructuring/rescue procedures), a company may utilize a scheme of arrangement to reach a compromise agreement with its creditors.
A scheme of arrangement is a Companies Act process, which requires two court hearings, including court sanction. It will bind all affected creditors (whether secured or unsecured) where at least 75% in value and over 50% by number of voting creditors favor of the scheme. Creditors that are treated differently may need to vote in separate classes. Schemes have proven effective to implement a variety of restructurings, including amends-and-extends, standstills, debt-to-equity swaps and other comprehensive reorganizations. Management stay in control of the company.
The Government has announced reforms to introduce a new restructuring plan process.
Can a debtor in restructuring proceedings obtain new financing and are any special priorities afforded to such financing (if available)?
There is no express provision for super-priority rescue financing in an insolvency process, such as the DIP financing regime available under the U.S. Bankruptcy Code. However, credit extended to a company in administration may be given priority over unsecured claims by virtue of classification as an administration expense.
To grant new financing super-priority, an intercreditor agreement is the simplest option. Where it is not possible to reach agreement with existing creditors, a scheme of arrangement may be used in certain circumstances to ‘cram-down’ a proposal on a dissenting minority; this could include an offer of new financing to the debtor on a super-priority basis.
Can a restructuring proceeding release claims against non-debtor parties (e.g. guarantees granted by parent entities, claims against directors of the debtor), and, if so, in what circumstances?
Yes, in certain circumstances; most commonly seen in schemes of arrangement. Claims against third party guarantors may be released or amended by the scheme if necessary for the successful operation of the scheme (to avoid ricochet claims against the principal debtor). A release of claims against persons involved in the preparation, negotiation or implementation of a scheme, and their legal advisors, is also permissible. Issues might, however, arise where a scheme creditor has a more tangential claim against a third party.
Is it common for creditor committees to be formed in restructuring proceedings and what powers or responsibilities to they have? Are they permitted to retain advisers and, if so, how are they funded?
Since the financial crisis of 2007-2008, we have seen a rise in ad hoc creditor committees over formal co-ordination or steering committees. Ad hoc committees are self-formed groups of creditors that will co-ordinate among themselves and the debtor on the implementation of the workout. Although the size of these groups can vary (from a minority ad hoc committee to one that holds substantially all the liabilities of a debtor), the crucial difference between an ad hoc committee and a more formal co-ordination or steering committee is that the former may act unilaterally, and is not necessarily representative of the wider stakeholder classes. Within this reduced scope, ad hoc committees can often act more quickly and more flexibly (but may only speak for one part of the capital structure).
An ad hoc committee will usually need to engage legal and financial advisers. It is a market custom (and often required in bank facility documentation) that the debtor pays the costs of creditors in connection with an event of default or in connection with any protection or enforcement of the security. This is usually memorialized in any waiver or new documentation entered into with the debtor for the workout.
How are existing contracts treated in restructuring and insolvency processes? Are the parties obliged to continue to perform their obligations? Will termination, retention of title and set-off provisions in these contracts remain enforceable? Is there any ability for either party to disclaim the contract?
The general rule is that a company’s contracts remain enforceable upon insolvency.
Properly drafted, a retention of title clause will survive an insolvency filing.
Contractual provisions allowing parties to terminate upon a counterparty’s insolvency will be upheld save in limited circumstances relating to certain essential supplies (e.g. gas, electricity, water and communication and IT services). (This is subject to proposed reforms to prevent reliance on ipso facto clauses - where the clause allows a contract to be terminated on the grounds of the counterparty’s insolvency - in supplier contracts.) There is also an ‘anti-deprivation’ principle which prohibits any contract from providing that property will transfer to another on the occurrence of an insolvency event.
In a liquidation or a distributing administration, statutory set-off applies where a creditor of the insolvent company is also a debtor of the company. Set-off is mandatory and automatic, and the relevant rules supersede all other contractual rights of set-off that are inconsistent with them.
A liquidator (but not an administrator) has the power to unilaterally disclaim onerous executory contracts to avoid incurring future liabilities.
What conditions apply to the sale of assets / the entire business in a restructuring or insolvency process? Does the purchaser acquire the assets “free and clear” of claims and liabilities? Can security be released without creditor consent? Is credit bidding permitted? Are pre-packaged sales possible?
An administrator can sell assets free and clear of security either with the relevant security-holder’s consent or with a court order (provided that the proceeds are used to discharge the sums secured by the security).
Unlike in a solvent sale, a buyer from an administrator will generally be expected to acknowledge that it enters into the agreement without reliance on any warranties or representations. A buyer may also be expected to provide wide ranging indemnities to the administrator.
Credit bidding in an administration sale process is permitted (including where the credit bidder is an assignee of the original creditor, and whether or not the administration is a pre-pack administration). However, there is no specific legislation on this point. It will be up to the administrator to decide whether a particular deal is in the best interests of the creditors and should therefore be implemented.
The administrators must comply with relevant legislation, including “Statement of Insolvency Practice 16” in the case of pre-pack administrations (which are possible and common), which include certain marketing / valuation requirements. Greater protections/constraints apply in sales to connected parties (widely defined).
What duties and liabilities should directors and officers be mindful of when managing a distressed debtor? What are the consequences of breach of duty? Is there any scope for other parties (e.g. director, partner, shareholder, lender) to incur liability for the debts of an insolvent debtor?
Directors of an English company owe fiduciary duties to the company itself. In the case of a healthy company, directors have a duty to act in a way most likely to promote the company’s success for the benefit of its shareholders as a whole. However, in the zone of insolvency - when the directors know or should know that the company is or is likely (i.e. probable) to become insolvent - this duty shifts to the creditors of the company.
A breach of these duties may lead to directors incurring personal liability or being disqualified from acting as a director or from being involved in the management of a company for a specified period. In some instances, it may lead to a criminal prosecution.
The principal potential causes of action are: wrongful trading, fraudulent trading, and a claim for misapplication of company property / misfeasance. Directors are generally most cognizant of the wrongful trading offence. Wrongful trading is established where a director knew or ought to have concluded that there was no reasonable prospect that the company would avoid insolvent liquidation or administration, and the director failed to take every step to minimise potential losses for creditors.
In addition to financial penalties, these offences can lead to a disqualification order for future directorships.
Liability may extend to third parties in certain, fairly limited, circumstances. TUPE regulations may apply when assets are purchased out of an administration: where the business is being carried on is substantially the same as before, all liabilities of employment transfer to the purchaser. This will include redundancy costs and unfair dismissal claims. The Pensions Regulator can exercise moral hazard powers over a connected third party that has acted in a way that has been materially detrimental to a defined benefit pension scheme of the debtor. The Regulator can issue a contribution notice against employers and their connected persons where relevant, demanding payment to remedy any shortfall in the pension scheme. Further, the European Commission and the Competition and Markets Authority have the power to reach behind the corporate veil when fines they have issued are left unpaid by an insolvent debtor and where there is a structural link with an economic successor entity.
Do restructuring or insolvency proceedings have the effect of releasing directors and other stakeholders from liability for previous actions and decisions?
There is no automatic release for directors or other stakeholders when a company enters an insolvency or restructuring process. Directors may often want to conduct sales through an administrator if they are concerned about breaching director’s duties. Alternatively, directors or other stakeholders may be able to negotiate a release of liability contractually (e.g. within a restructuring agreement).
Will a local court recognise concurrent foreign restructuring or insolvency proceedings over a local debtor? What is the process and test for achieving such recognition? Has the UNCITRAL Model Law on Cross Border Insolvency or the UNCITRAL Model Law on Recognition and Enforcement of Insolvency-Related Judgments been adopted or is it under consideration in your country?
The UK is, currently, party to the Recast European Insolvency Regulation. This regime provides for automatic recognition of certain collective insolvency proceedings in all European Member States. The extent to which that regime - or a bilateral treaty replicating elements of that regime - might apply post-Brexit remains uncertain.
The UK has adopted the UNCITRAL Model Law on Cross Border Insolvency, via the Cross Border Insolvency Regulations 2006. This permits recognition of the foreign proceedings, and assistance for the foreign insolvency officeholder (including a moratorium), upon application to the court - usually a fairly predictable court procedure. However - critically - such recognition does not necessarily extend to recognition/enforcement of the plan of reorganization with the foreign proceedings. In essence:
- If debt (or shareholder rights) compromised under the plan are governed by English law, the English court will only recognize/enforce the compromise in respect of creditors(/shareholders) subject to the foreign proceedings – owing to the so-called “rule in Gibbs”.
- For these purposes, creditors will be subject to the foreign proceedings if they were present in the foreign jurisdiction when the proceedings commenced, submitted a proof of debt or voted in the proceedings (among other things).
- A parallel UK process may therefore be required to compromise the English law debt, if not all creditors are subject to the foreign proceedings and if parties require certainty.
We understand the UK is likely to adopt the UNCITRAL Model Law on Recognition and Enforcement of Insolvency-Related Judgments in due course, to address the above concerns.
Can debtors incorporated elsewhere enter into restructuring or insolvency proceedings in the jurisdiction?
Yes; the jurisdictional threshold varies according to the relevant procedure, and looks set to change on Brexit. There are a variety of ways for a foreign debtor to access the jurisdiction, including e.g. by shifting the company’s center of main interests (CoMI) to the UK.
How are groups of companies treated on the restructuring or insolvency of one or more members of that group? Is there scope for cooperation between office holders?
Under English law, each company in a corporate group is treated as a single entity and its directors are required to consider the interests of creditors in relation to that particular company (rather than the group as a whole). Unlike in Chapter 11, we do not have a formal concept of group proceedings / joint debtors, or substantive consolidation. However, the commercial reality is that what is beneficial for a group is often beneficial for each individual company, and there is scope for co-ordination between affiliated entities.
The Recast European Insolvency Regulation makes specific legislative provision to try to facilitate co-ordination between officeholders (albeit on a voluntary basis).
Is it a debtor or creditor friendly jurisdiction?
The UK has historically been perceived as a creditor-friendly jurisdiction (in particular for senior secured creditors), but it is extremely effective for both creditors and debtors. The English courts are the forum of choice for major international financial and other contracts, because the system is seen as flexible and commercially-oriented whilst also offering certainty and predictability - with considerable deference to the commercial terms agreed by the parties - and the highest possible reputation for independence / lack of corruption.
Overseas debtors have increasingly looked to take advantage of the English restructuring and insolvency framework, including taking steps to establish jurisdiction here e.g. by moving the debtor’s CoMI, amending the governing law of their debt documents, or otherwise.
Do sociopolitical factors give additional influence to certain stakeholders in restructurings or insolvencies in the jurisdiction (e.g. pressure around employees or pensions)? What role does the state play in relation to a distressed business (e.g. availability of state support)?
Generally, the UK does not have the major sociopolitical factors impacting restructurings that exist in certain other jurisdictions, and state involvement in distressed businesses is generally limited to non-existent.
Certain unpaid contributions into occupational pension schemes and contributions deducted from the employee’s pay are categorized as preferential debts and will rank ahead of floating charge holders in the event of a company’s insolvency. The Government also plans reforms to the preferential creditor regime, to make the UK tax authority, HMRC, a “secondary preferential creditor” for certain tax debts, including VAT and PAYE, from April 2020, as mentioned above.
The Pension Protection Fund provides compensation for defined benefit occupational pension scheme members on an employer’s insolvency. The Pensions Regulator has very wide ‘moral hazard’ or ‘anti avoidance’ powers to make third parties liable to provide support or funding to a defined benefit occupational pension scheme in certain circumstances.
Large pension schemes of debtors in difficulty will attract greater public attention and government intervention is more likely, e.g. by seeking to facilitate a deal between the debtor, the Pensions Regulator and unions (if any). Aside from these considerations, state involvement is generally limited.
What are the greatest barriers to efficient and effective restructurings and insolvencies in the jurisdiction? Are there any proposals for reform to counter any such barriers?
There are three, in our view: the lack of a true pre-insolvency restructuring procedure with provision for cross-class cram-down; questions of UK recognition of foreign plans of reorganization, and questions of EU recognition of UK proceedings post-Brexit.
- Lack of a true pre-insolvency restructuring procedure with provision for cross-class cram-down: The absence of such a procedure has not prevented many efficient and effective restructurings and insolvencies. However, we (broadly) welcome reforms announced in August 2018, including a new procedure which will be akin to Chapter 11 in certain respects and will include the possibility of cross-class cram-down. Timing of the reforms is uncertain.
- UK recognition of foreign plans of reorganization: See Question 16. above. The UK is likely to implement the new UNCITRAL Model Law on Insolvency-Related Judgments in due course, but there is no indication of timing.
- EU recognition of UK proceedings post-Brexit: There are uncertainties around Brexit and its impact on the English restructuring and insolvency regime. In particular, if the UK leaves the EU, absent alternative arrangements, EU member states will no longer automatically recognize UK insolvency proceedings. This will be a matter of the private international law regimes in each Member State. At the time of writing (May 2019), there is no known date for Brexit.