Long awaited insolvency reforms in the UK, plus the government’s COVID-19 proposals on the use of statutory demands – and much more

What’s the latest?

As we reported on 24 April, the government announced curbs to landlords’ “aggressive” rent collection tactics of serving statutory demands and presenting winding-up petitions during the COVID-19 pandemic.  The details of these curbs have finally been published in the draft Corporate Insolvency and Governance Bill, which had its first reading in the House of Commons on Wednesday 20 May.

Is the Bill just aimed at real estate and COVID-19?

Absolutely not.  Whilst the Bill introduces measures previously announced to combat the economic effects of the COVID-19 pandemic, it also includes measures contained in the government’s “A Review of the Corporate Insolvency Framework” consultation published in 2016.  These include what is essentially a new insolvency process, the company moratorium, aimed at helping struggling businesses restructure and, at the same time, limiting enforcement action that can be taken against them by creditors (including landlords).

It amounts to a substantial updating of UK insolvency law, some of which has specific application to real estate and landlord remedies in the COVID-19 crisis.

A wider review of the insolvency law changes is available here; however, for the purposes of this blog we have focussed on some of the aspects which will be of most interest to landlords dealing with struggling tenants.

Why is the government concerned about landlords’ use of statutory demands?

We’ll look first at the issue landlords and tenants have been most concerned about in the context of rent recovery. Landlords have been looking to use statutory demands as an effective means to encourage payment and engagement from tenants who do not (but perhaps could) pay their rent during the COVID-19 crisis.

The government’s issue is that an unsatisfied statutory demand can be used by a landlord as evidence that a company cannot pay its debts and grounds to present a winding up petition to force a company into liquidation: “Insolvency proceedings of this nature are not intended to be used as a tool for debt collection but are to deal with financial failure and tackle companies that are no longer viable”, the government explains.

In passing it seems this view has been supported by the courts.  Last month an injunction was obtained by a tenant debtor against a threatened petition resulting from a statutory demand served by the landlord for unpaid rent.  The court held that service of a statutory demand was an inappropriate use of the insolvency process (which is in keeping with the government’s approach).  The curious outcome is that this effectively means the tenant has successfully argued that it should be protected from winding-up for non-payment of rent, because it can pay its rent – but hasn’t paid it and doesn’t commit to the court to pay it.

So what is changing? 

The government is legislating to temporarily prevent winding-up proceedings being taken on the basis of statutory demands and to temporarily stop winding-up proceedings where COVID-19 has had a financial effect on the company which has caused the grounds for the proceedings.

The provisions apply to all UK companies, not (as might have been assumed from the original announcement) just landlords and commercial tenants or even the retail and hospitality sectors, and in the main take effect retrospectively from 27 April 2020.

What does that mean in practice?

No petition can be presented on or after 27 April 2020 based on a statutory demand served in the “relevant period” of 1 March to 30 June 2020 (or, if later, one month after the legislation comes into force, which is likely to be relevant here, as this legislation is unlikely to come into force before 30 May 2020).
A petition based on an inability to pay debts cannot be presented by a creditor in the relevant period unless the creditor has reasonable grounds for believing that:

• “coronavirus has not had a financial effect on the company”; or

• the company’s inability to pay was not caused by the COVID-19 pandemic.

Any petition presented after the legislation comes into force, but before the end of the relevant period, must include a statement from the creditor to that effect.

In reality, no creditor will be able to rely on the first ground above, because there will be very few companies who have not been affected, in one way or another, by COVID-19.  Presumably, if the company is able to pay but is simply choosing not to, a creditor cannot issue a winding-up petition at all.

In effect, it is for the landlord creditor to prove to the court that it has reasonable grounds for believing that the tenant’s failure to pay is not caused by COVID-19.  This is clearly going to be extremely difficult for a landlord to do without access to a tenant’s financial data.  Landlords will have hoped that it would have fallen on the tenant to prove that COVID-19 had caused it to be unable to pay its rent, but the government has seen fit to place the burden of proof on the landlords, which seems unfair, as it should be the tenant, who should have to justify not having paid its rent.

Should landlords rush to seek winding-up orders before the legislation comes into force?

In case any landlords wish to rush to present winding-up petitions before the legislation comes into force, retrospective provisions give tenants further protection and make this a fairly futile course of action.

For petitions presented in the period between 27 April 2020 and the legislation coming into force, the court can make appropriate orders to restore the debtor’s position to what it was before the petition was presented if the creditor did not hold the necessary belief about the non-impact of COVID-19.

Furthermore, and quite remarkably, winding-up orders which would not have been made had the legislation already come into force are rendered void (although protection is given to a liquidator in respect of any actions taken based on the order).

What is the new company moratorium?

The Bill introduces a new free-standing moratorium process as Part A1 to the Insolvency Act 1986, and the existing small company CVA moratorium is repealed.

The moratorium provides companies with breathing space from creditor action if they are, or are likely to become, unable to pay their debts and it is considered that the moratorium will allow the company to be rescued as a going concern.

Available to UK registered and unregistered companies liable to be wound up under Part 5 of the Insolvency Act 1986, the moratorium will last for an initial period of 20 business days but can be extended:

• by the directors for another 20 business days;

• with creditor consent for a total period (including the initial 20 business day period) of a year; and

• by the court for an unlimited period.

As this is a debtor-in possession process, the directors will have to be in charge of the day to day running of the company but the process will be overseen by a monitor who has to be a licensed insolvency practitioner.  This is not too dissimilar to the light-touch administrations we have seen recently, although the monitor will have a more limited role.

Consequences of the moratorium for landlords

On the plus side for landlords, the moratorium means that personal and business relationships will remain unchanged as no insolvency practitioner is, for example, appointed to run the company in place of the existing directors.  It also means that valuable resources are not diverted from business operations into meeting more extensive costs, e.g. of an administration.

Pre-moratorium debts (being those falling due before the moratorium and those falling due during the moratorium but arising from an obligation incurred prior to the moratorium) benefit from a payment holiday during the moratorium, aimed at easing the struggling company’s cash flow.  Pre-moratorium debts which are subject to the payment holiday can be paid but only up to a specified cap per creditor, unless the monitor consents.

However, importantly for landlords, certain pre-moratorium debts won’t benefit from that holiday including rent in respect of a period during the moratorium.  Although there is nothing in the Bill requiring the company to pay debts without a holiday, the directors have to confirm that the debts have been paid before they can extend the moratorium, and the monitor has to bring the moratorium to an end if it thinks the company is unable to pay these debts – both of which may provide some comfort to landlords that the company will continue to make rent payments during the moratorium.

Unfortunately for landlords the moratorium does also mean that certain actions are prohibited without the consent of the court including:

• commencing insolvency or legal proceedings;

• action under the Commercial Rent Arrears Recovery Regime (the draft legislation still refers to the old term of “distress”); and

• forfeiture by peaceable re-entry.

This is similar in many ways to the moratorium arising on the appointment of administrators.

Unintended consequences?

The Bill provides, in relation to any contract “for the supply of goods or services”, that where the contract includes a provision allowing the supplier to terminate the contract or “do any other thing” when a company becomes subject to a relevant insolvency procedure (including but not limited to the new company moratorium, administration or liquidation), such provision will “cease to have effect” when the company becomes subject to the relevant insolvency procedure.

It is not inconceivable that you could construe a lease as a contract for the supply of “goods or services”, and the result of the draft legislation may be that some tenants will try to argue, for example, that a landlord is unable to rely on a right to forfeit relating to a relevant insolvency procedure.  Hopefully, government will take the opportunity to clarify that this is not the case.

The Bill is before Parliament.  Will it change much and when will it become law?

We have no reason to think that the Bill will change particularly before it becomes law, and we assume that the government is keen for it to receive Royal Assent as soon as possible.  Expect to see it on the statute books shortly.

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