This country-specific Q&A provides an overview of the legal framework and key issues surrounding restructuring and insolvency in United Kingdom.
This Q&A is part of the global guide to Restructuring & Insolvency.
For a full list of jurisdictional Q&As visit http://www.inhouselawyer.co.uk/practice-areas/restructuring-insolvency/
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.
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”. A fixed charge requires the security provider (the chargor) to hold the charged asset 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 (e.g. cash in an account, stock and inventory). Charges are more commonly found in the case of movable property, receivables and shares. Fixed charges over real estate most commonly arise as part of an “all asset” security package. Lenders often take a fixed charge over any real estate acquired after the security has been granted. They are both 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 other creditors. Other types of security, e.g. over intellectual property, require further formalities.
What practical issues do secured creditors face in enforcing their security (e.g. timing issues, requirement for court involvement)?
If a lender has security over a particular asset or group of assets (for example, the company's real estate or its shares), they will often enforce their security by appointing a receiver (usually an insolvency practitioner) over the asset. The appointment can be made without court involvement provided that the security document has been properly drafted and executed. Following the appointment, the receiver will have power to collect in any income from the asset and to sell it.
A lender may also exercise their own power of sale if they have a legal mortgage or if the terms of the security document otherwise permit. A receiver or a lender making a sale is obliged to get the best price reasonably obtainable in the circumstances but 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.
If a lender has security over all or substantially all of the company's assets (including a floating charge), the lender would usually have a “qualifying floating charge” (or QFC). Once their security becomes enforceable, a QFC holder may appoint an administrator (usually an 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.
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.
If a company is insolvent under any of these tests, it may be placed into administration or liquidation.
There is no obligation on directors to commence insolvency proceedings but directors may be personally liable if they breach certain duties as set out in Question 13 below. Civil penalties against directors can be for wrongful trading if they fail to take all steps to minimise potential losses to creditors. However, if they intentionally fail to do this, a criminal penalty for fraudulent trading may be imposed.
The insolvency tests above are also used to determine if a transaction occurred in the zone of insolvency. Such transactions may be challenged by an administrator or liquidator or other creditors in certain circumstances.
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?
Where insolvency cannot be avoided, a company will either file for (or be filed for) administration or liquidation (also known as a winding up).
The key insolvency procedure with a view to company rescue is administration. Similar to the US 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 will be an 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 the best possible result for creditors. 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” sales are particularly prevalent in the UK, being processes in which the debtor and its creditors conclude a deal to sell the debtor’s business as a going concern on the day of the administrator’s appointment, thereby minimising the period in which the company is subject to insolvency proceedings.
When there is no reasonable prospect of rescuing a company as a going concern, liquidation will generally be the only option. An administration can also be converted into a liquidation whereby the business is wound down and the assets liquidated.
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: firstly, to fixed charge holders; secondly, in payment of the administrator/liquidator’s fees and expenses; thirdly, to preferred creditors; fourthly, to floating charge holders; fifthly, to unsecured creditors; sixthly, as post-petition interest on all unsecured debts; and finally, to the shareholders.
Preferred creditors include certain employee claims and contributions to pension schemes. In addition, a “prescribed part” of the proceeds realised from floating charge assets must be set aside and made available to satisfy unsecured debts. This is calculated as 50% of the first £10,000 of net floating charge realisations plus 20% of anything thereafter, up to a cap of £600,000.
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?
When a company has entered a formal insolvency process, certain transactions entered into by the company before the start of the insolvency may be challenged under provisions in the Insolvency Act 1986.
Possible grounds for challenge include transactions at an undervalue, preferences, extortionate credit transactions, avoidance of floating charges, and transactions defrauding creditors. Each of these grounds aim 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; however, where there is fraud, any party that is a victim of the transaction may make a challenge.
A successful challenge will result in the offending transaction being unwound by a court order. The court order will not affect third parties who acted in good faith and for value. The look back period ranges between two years for connected parties (including directors, shadow directors, and associated persons and companies) to six months for other parties. Penalties for these transactions can include: accounting for profits for proceeds to the company or the transaction being voided.
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. In administration, no third party can without the consent of the administrator or the court’s permission: (i) take steps to enforce security or otherwise repossess property (including a landlord’s right of forfeiture by peaceable re-entry); or (ii) institute or continue any legal process (including legal proceedings, execution, distress and diligence) against the company or its property.
In a liquidation, no action or proceedings can be continued or raised without the leave of the court. Secured 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).
A company voluntary arrangement (CVA) can also offer a moratorium (including in respect of security enforcement) in certain exceptional circumstances applying to small companies (i.e. a company satisfying two or more of the following criteria: (i) turnover of less than £6.5m, (ii) balance sheet of less than £3.26m or less than 50 employees). A scheme of arrangement (unless combined with an administration) does not offer a moratorium.
Unlike in the US, a moratorium under English law does not purport to have extraterritorial effect. Its recognition under the laws of another jurisdiction will depend on applicable treaty arrangements. For example, EU Member States that are signatories to the EU Insolvency Regulation recast will give assistance to the English proceeding (including by recognising the related moratorium in the relevant Member State) where it can be established that the COMI of the debtor is in, or such debtor has an establishment in, England (although see Question 20).
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 an administration, discussed at Question 4 above, a company may utilise other statutory procedures to reach a compromise agreement with its creditors.
The principal two procedures are (1) a company voluntary arrangement (CVA); and (2) a scheme of arrangement. For both of these procedures, management stay in control of the company. Either may be used in conjunction with an administration to utilise the moratorium.
A CVA is implemented out of court unless it is challenged. It binds all unsecured creditors and, if they voluntarily agree to be bound, secured creditors. The requisite consent is 75% in value of unsecured creditors and 50% in value of those unsecured creditors that are unconnected to the debtor. We have seen a recent increase in the use of CVAs, in particular in the retail and casual dining sectors, to restructure liabilities owed to landlord creditors.
A scheme of arrangement is conducted in court and requires court sanctioning. It will bind all creditors where 75% in value and 50% in number of voting creditors favour 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, debt-to-equity swaps and other comprehensive reorganisations.
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 regime available pursuant to the US Bankruptcy Code.
To grant new financing super-priority status, 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, which could include an offer of new financing to the debtor on a super-priority basis, on a non-consenting minority.
In addition, credit extended to a company in administration may be given priority over unsecured claims by being classified as an administration expense.
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 coordinate 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 substantial all the liabilities of a debtor), the crucial difference between an ad hoc committee and a more formal coordination 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 memoralised 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 an 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 essential supplies (e.g. gas, electricity, water and communication and IT services). 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 securityholder’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 (including where the credit bidder is an assignee of the original creditor) in an administration sale process or pre-pack is permitted, although there is also 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 so should be implemented. Where there are no other bidders, it would be prudent to demonstrate that a marketing process was pursued (and that there was no other available bidder) or to obtain an independent valuation of the assets being sold.
Pre-packaged sales are possible and common in the UK. The perceived lack of transparency and creditor consultation associated with pre-packs has attracted increased scrutiny, especially where assets are sold to a purchaser connected to the debtor. A voluntary independent assessment system – the ‘pre-pack pool’ – has been set up with the aim of increasing transparency and credibility of such transactions.
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 (which, in good times, means its shareholders, but in the zone of insolvency, this shifts to the creditors or potential creditors of the company).
The main heads of liability for directors in the zone of insolvency are wrongful trading and misfeasance. Note that other forms of liability may be found in relation to publicly traded companies. Misfeasance relates to the breach of fiduciary duties and, specifically, the misapplication of the debtor’s funds.
Directors are generally most cognisant of the wrongful trading offence, which is designed to force directors to take all steps to minimise losses to creditors. Wrongful trading is established where a director knew or ought to have known that there was no reasonable prospect that the company would avoid insolvent liquidation and the director failed to take every step to minimise potential losses for creditors.
Apart from financial penalties, any one of these offences can lead to a disqualification order for future directorships or criminal penalties including fines.
Liability may extend to third parties in certain 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 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. in a restructuring agreement).
Further, there are some transactions that may be reviewable by an insolvency practitioner. These most notably include: transactions at an undervalue, preferences and invalid floating charges and are all provided for in the Insolvency Act 1986. These are all subject to look back periods that vary according to whether the transaction was entered into with a party connected with the company or a director.
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 been adopted or is it under consideration in your country?
The UK is, currently, party to the Insolvency Regulation recast which governs the recognition of foreign insolvency regimes in Europe. As a result, any proceedings opened in other Member States will be recognised in England and Wales upon application to the court. Where the debtor is local and has its COMI in England and Wales, proceedings opened in England will be considered as main proceedings and secondary proceedings may be opened where the debtor carries out non-transitory economic activity with human means and goods (an “establishment”). Secondary proceedings may only be: winding up proceedings, limited to the assets in that Member State and run in parallel with the main proceedings.
Beyond this, the UK is a signatory to the UNCITRAL Model Law, which provides the framework for recognition of proceedings opened in other jurisdictions (and has been implemented in England by the Cross Border Insolvency Regulations 2006). However, not all major jurisdictions have implemented the Model Law. In that scenario, a scheme of common law rules govern how any foreign proceedings over a local debtor could potentially be recognised. These rules are somewhat vague and offer far less certainty.
Can debtors incorporated elsewhere enter into restructuring or insolvency proceedings in the jurisdiction?
Under the Insolvency Regulation recast, a debtor may enter into a restructuring process in another Member State to its incorporation if it has its COMI or it has an establishment in that Member State. This allows non-English companies to utilise CVAs and other insolvency processes. If neither of these criteria is met, that jurisdiction should refuse to open proceedings.
English courts have been willing to recognise the COMI of a debtor as being in England even where it has recently been moved to benefit from an English insolvency procedure such as an administration. A debtor’s COMI is defined as the place in which the debtor conducts the administration of its interests on a regular basis and is ascertainable as such by third parties. Shifting COMI to England would typically involve a change of registered office, the migration of its assets and liabilities and communications to stakeholders to ensure that the new headquarters is ascertainable by third parties.
Foreign debtors often seek to use the scheme of arrangement to implement a variety of restructurings. In order to do this, the court must be satisfied that the debtor has a sufficient connection to the jurisdiction. This is a fact-specific analysis but a sufficient connection can be shown if the underlying credit agreements are English law governed or the debtor’s COMI is in England. Recent decisions have also suggested that changing the governing law and jurisdiction clause of the credit agreements to English law can help in demonstrating a sufficient connection to the English jurisdiction.
How are groups of companies treated on the restructuring or insolvency of one of 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). 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 Insolvency Regulation recast makes specific legislative provision to try to facilitate co-ordination between officeholders (albeit on a voluntary basis).
The case may be different where a group may be looking to offload an unprofitable subsidiary through an insolvency process. Given the need to consider the creditors of each company on an individual basis, directors that sit on both group and company boards in such a scenario may need to consider whether a conflict of interest exists and, if so, recuse themselves from one of the boards.
Is it a debtor or creditor friendly jurisdiction?
The English restructuring and insolvency regime 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.
Overseas debtors have increasingly looked to take advantage of the flexibility of the English regime (e.g. by using schemes of arrangement or administrations) and they have established jurisdiction by moving their COMI, amending the governing law of their debt documents, or otherwise.
The courts have been in certain cases particularly accommodating to foreign debtors. In Codere, it was found that incorporating an English subsidiary that assumed the debtor group’s liabilities could be sufficient for the court to establish jurisdiction for a scheme of arrangement. The court considered that ‘forum shopping’ in this manner may be justified if there is a compelling case that a scheme will be more favourable than alternative restructuring regimes in foreign jurisdictions (and much reliance was placed on the considerable creditor support in that case).
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)?
Certain unpaid contributions into occupational pension schemes and contributions deducted from the employee’s pay are categorised as preferential debts and will rank ahead of floating charge holders in the event of a company’s insolvency.
The Pension Protection Fund (PPF) 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 (e.g. BHS) 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?
The UK’s departure from the EU (Brexit) is formally due to occur on 29 March 2019, following which a transition period is expected. It remains to be seen what the impact of Brexit and the transition period will be on the English restructuring and insolvency regime.
As a member of the EU, the UK has had the benefit of the Insolvency Regulation recast, which, as noted above, gives primacy to insolvency proceedings opened in the Member State of the debtor’s COMI. Once the UK leaves the EU (and without any agreement to the contrary), the treatment of English insolvencies by other Member States will be subject to their national private international law regimes. This could threaten the attractiveness of the English insolvency regime to foreign debtors. The loss of the Insolvency Regulation recast is less significant in the case of schemes of arrangement however, which are a company law (rather than insolvency) process.
In relation to schemes, an as yet unresolved matter is whether the Brussels I Regulation applies when considering the court’s jurisdiction to sanction a scheme proposed by a debtor incorporated in another Member State. An affirmative answer would place a limitation on the court’s jurisdiction. The court’s recent practice has been to assume that the Regulation does apply (without deciding the issue) and then to find jurisdiction so long as the proposed scheme would satisfy one of the Regulation’s exceptions, in particular Art. 8 or Art. 25 (e.g. see Van Gansewinkel Groep). If a scheme company cannot rely on these exceptions, the court will be required to decide this issue before sanctioning scheme. Of course, if Brexit is to involve the disapplication of the Brussels I Regulation from English law, the court will not be so impeded.