Legislating for the Insolvency Impact of the Coronavirus Crisis

Legislating for the Insolvency Impact of the Coronavirus Crisis
2020-04-16

This is the third in a blog post series being produced under the auspices of the Centre for Commercial Law in response to the coronavirus crisis.

Introduction

The economic fallout of the coronavirus crisis is becoming more apparent with each passing day. The forecasts and analyses range from gloomy to apocalyptic: research indicates that nearly a fifth of SMEs in the UK are unlikely to get the finance they need to survive the rest of this month; the IMF’s managing director has acknowledged that the world is facing its worst economic crisis since the Great Depression; and one commentator has suggested that this is the fastest and deepest economic shock in recorded history, with a “Greater Depression” on the horizon.

The prospects for a speedy recovery are certainly unclear but it is already obvious that the number of insolvencies will significantly increase. To minimise the economic impact, states have sought to offer unprecedented financing to stave off both personal and business insolvency (where that is possible) and are also turning their attention to insolvency law to mitigate negative effects of the crisis. This blog article considers insolvency law developments that have taken place since the publication of our previous contribution, Debt and Insolvency Law in the Age of Coronavirus. It focuses, in particular, on legislative responses to the coronavirus crisis in Scotland and the UK, but also gives attention to other jurisdictions, namely Germany, Australia and the USA.

 

Scotland

The law of bankruptcy (non-corporate insolvency) is devolved to the Scottish Parliament. This contrasts with corporate insolvency, which (apart from certain exceptions) is reserved to the UK Parliament (Scotland Act 1998, Sch 5, Section C2).

On 1 April 2020, the Scottish Parliament passed the Coronavirus (Scotland) Act 2020 with Royal Assent being given on 6 April 2020. Publicity regarding the passage of the legislation was dominated by discussion of the provision that would have temporarily abolished jury trials (a proposal that was dropped following strong criticism from various quarters). However, the legislation contains provisions that are directly and indirectly relevant to insolvency law. Most notably, section 3 gives effect to Schedule 2 of the 2020 Act, which extends moratoriums on diligence provided for in Part 15 of the Bankruptcy (Scotland) Act 2016. The provisions of the 2020 Act expire on 30 September 2020, but there are powers for Scottish Ministers to extend the period by regulations to 31 March 2021 and again, thereafter, to 30 September 2021 (s 12). There is also a power to bring forward the expiry date (s 13).

By way of background regarding the amended law, there is a moratorium on doing diligence against the assets of a person (a consumer, a sole trader or one of the legal entities to which the legislation applies) who gives notice under s 195(1) or s 196(1) of the Bankruptcy (Scotland) Act 2016. These provisions involve a person giving notice to the Accountant in Bankruptcy of that person’s intention to make a debtor application for sequestration (a formal personal insolvency process) under ss 2(1)(a) or 6, or to seek to fulfil the conditions required for a trust deed granted by that person to become a protected trust deed, or to apply for the approval of a debt payment programme in accordance with s 2 of the Debt Arrangement and Attachment (Scotland) Act 2002. This notice may not be given if the person has provided such notice in the immediately preceding 12 months. However, under the new legislation, this prohibition is disapplied, so that someone who has given notice in the preceding 12 months is able to provide notice once again and can obtain the benefit of the moratorium (2020 Act, Sch 2, paras 2 and 3).

The general period of the moratorium is temporarily extended from 6 weeks to 6 months under the 2020 Act (Sch 2, para 4(a)). However, it is unclear if the 6 month period will apply in full if a moratorium commences when the 2020 Act is effective but where the Act’s provisions expire before the end of the 6 months. In any event, the expanded moratorium period provides a debtor with enhanced protection from the claims of creditors, which may become increasingly difficult to pay as the coronavirus crisis continues. The extension of the moratorium period gives more time for a debtor to access money advice, but the advice services are already stretched. Given the likely significant uplift in demand, will those services be able to cope without increased funding, which may not be forthcoming due to other spending priorities? There are also practical issues of access to such services during the lockdown period. In addition to the general moratorium extension, there are other temporary statutory provisions that will not be discussed here.

The provisions in the 2020 Act constitute a rather narrow and focused intervention in the field of bankruptcy law. There is a possibility that as the financial impact of the crisis becomes more apparent further relevant measures will be introduced, such as limitations on enforcement by creditors. At the present time, there are already considerable practical restrictions on a creditor obtaining payment (not least the fact that court business has been severely limited, as noted below) but as some of the restrictions are lifted, there could be a need to further protect debtors in a vulnerable economic position.

In the meantime, there are other provisions in the legislation that also have relevance for debt and insolvency law. Individuals are given extended protection from eviction from their homes (s 2 and Sch 1) in circumstances including, but not limited to, non-payment of rent, and tenants of commercial premises are also given extended protection from irritancy for non-payment of rent (s 8 and Sch 7, paras 6 and 7). Similar protections have also been introduced in England and Wales (see the Coronavirus Act 2020, s 81 and Sch 29 in relation to residential tenancies and s 82 in relation to commercial premises). Furthermore, the Accountant in Bankruptcy has suspended sales and evictions in ongoing sequestrations where AiB is the trustee in sequestration and is encouraging trustees in other sequestrations to do the same as well as introducing a raft of other measures to assist debtors.      

The present limitations on the work of the courts are also affecting insolvency law matters. The sheriff court will still deal with “urgent insolvency and sequestration applications”, yet it is not wholly clear what constitutes “urgent” in the midst of the current crisis. It might also be possible for other insolvency law work to be dealt with by the courts if urgency is shown but there is even more uncertainty on this point. Non-urgent insolvency law matters will, it seems, have to await the lifting of restrictions, although if the restrictions remain in place for an extended period, it is likely that representations will be made to seek to encourage the courts to deal with more routine business.

 

UK

There has also been activity at UK level in relation to altering insolvency law on a temporary basis. The UK Government has announced that wrongful trading rules will be suspended for three months with retrospective effect from 1 March 2020. The current wrongful trading provisions are in s 214 and s 246ZB of the Insolvency Act 1986, and were introduced to the UK for the first time by that legislation; corresponding provision is also made for limited liability partnerships. Where wrongful trading applies, a court can declare that a relevant director (or former director) of a company is liable to make a contribution to the company’s assets. Ordinarily, wrongful trading occurs where a company has gone into insolvent liquidation or insolvent administration and at some earlier point a director “knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation or entering insolvent administration” (IA 1986, s 214(2) and s 246ZB(2)) but continued to trade. It is expected that legislation dealing with wrongful trading will be introduced soon after Parliament returns from recess on 21 April 2020.

Misfeasance (IA 1986, s 212), fraudulent trading (IA 1986, s 213 and s 246ZA) and director disqualification rules (including the recently introduced provisions on compensation orders) will continue to apply and can therefore still give rise to personal liability for directors. However, some organisations, including R3 (the Association of Business Recovery Professionals), have concerns that a blanket suspension of wrongful trading rules will be open to abuse by directors. It is certainly possible that directors who ought to put a company into insolvency in the interests of creditors (irrespective of the impact of coronavirus), will continue to trade and thereby ultimately cause loss to the company’s creditors. An alternative approach would be for the wrongful trading rules to be disapplied where the trading took place at a time when the company’s insolvency or impending insolvency was the result of the coronavirus crisis. A rebuttable presumption in favour of such disapplication of the rules could even be used to give broad protection to directors. In addition, the steps taken by other jurisdictions in relation to their equivalent rules are worth considering as examples for the UK to potentially follow (see further below).

The crisis has also caused the UK Government to bring forward planned changes to insolvency law. It will seek to introduce reforms that were previously proposed in 2016 and then again in revised form in 2018. There will no doubt be some additional changes in comparison to the earlier proposals and more detail is awaited with interest. In general terms, the reforms will include:

  • A moratorium for companies providing “breathing space” from creditors enforcing their debts for a period of time whilst the companies seek a rescue or restructure;
  • A protection of companies’ supplies to enable them to continue trading during the moratorium (by prohibiting the operation of “termination clauses” by suppliers that seek to allow termination of contract when one of the parties enters a formal insolvency process); and
  • A new restructuring plan, which binds creditors to that plan (which will be similar to the current Scheme of Arrangement in the UK but with elements of the US Chapter 11 bankruptcy procedure).

The UK Government has stated, however, that the proposals will include safeguards for creditors and suppliers to ensure they are paid while a relevant solution is sought.

Depending upon how matters progress in the coming weeks, other changes could be introduced temporarily. These might include restrictions on the ability of creditors to present winding up petitions and other limitations on enforcement by creditors.

In terms of personal insolvency in England and Wales, the government could also use the present opportunity to bring forward the introduction of the “breathing space scheme” which was planned to come into force in 2021. This scheme would give someone with debt problems the right to legal protections from action by creditors while receiving debt advice in order to enter an appropriate debt solution. There would also be the opportunity to enter a statutory debt repayment plan, which would enable someone in problem debt to enter an agreement to repay their debts in accordance with a manageable timetable (while receiving protections from creditor enforcement during the plan’s duration). The proposed scheme is comparable to the “debt arrangement scheme” that was introduced to Scots law by the Debt Arrangement and Attachment (Scotland) Act 2002, Part 1.

 

Other Jurisdictions

Of course, the negative economic effects of the coronavirus crisis are a worldwide problem and a number of jurisdictions have already sought to amend their insolvency laws in response.

In Australia, for example, the Coronavirus Economic Response Package Omnibus Act 2020 has, amongst other things, relaxed insolvent trading rules relating to company directors for six months. However, the relief from the rules only relates to debts incurred “in the ordinary course of the company’s business” and not where there is dishonesty and fraud. This requirement for relevant debts to be incurred in the ordinary course of business for insolvent trading laws not to apply could usefully be adopted in the UK in relation to the temporary amendments to wrongful trading rule.

Australia has also temporarily increased the threshold for creditors issuing a statutory demand (from $2,000 to $20,000), which can lead to the liquidation of a company, and has increased the debtor’s response period for statutory demands (from 21 days to 6 months). Similarly, for individuals, the minimum debt threshold for initiation of bankruptcy proceedings by a creditor has been raised (from $5,000 to $20,000) and the time for the debtor to respond to a bankruptcy notice has been increased too (from 21 days to 6 months). Consideration should be given by the Scottish and UK governments as to whether similar changes should be made to the equivalent thresholds in the Bankruptcy Act 2016 and the Insolvency Act 1986 respectively. This may become a more pressing concern as debtors become less able to pay debts to creditors due to cash-flow and other income difficulties if the current restrictions remain in place for an extended period.

Under German law, directors of a company must ordinarily file for formal insolvency without undue delay and at the latest within 21 days after the company becomes insolvent (based on illiquidity or over-indebtedness). However, the COVID-19 Insolvenzaussetzungsgesetz suspends the obligation to file a request for insolvency. This does not apply where the insolvency is not a consequence of the spread of the pandemic or where there are no prospects of remedying the insolvency. Where the debtor was not illiquid on 31 December 2019, it is assumed that the insolvency is a consequence of the pandemic and that there are prospects of remedying the insolvency. A similar condition, based on the solvency of a company at a particular date, might be usefully included in the UK reforms to create a presumption as to when a director will not be deemed to have engaged in wrongful trading.

The German legislation provides that payments made in the ordinary course of business, in particular those payments which serve to maintain or resume business operations or to implement a restructuring concept, are deemed to be consistent with the due care of a prudent director. This provision, which somewhat explains what is meant by payments made in the ordinary course of business, could also be used as a template for reform in the UK in determining when directors will not be breaching duties under the wrongful trading laws.

Various other countries are enacting temporary reforms to deal with the crisis, including the USA, where the Coronavirus Aid, Relief, and Economic Security Act has been passed. This legislation contains a number of provisions dealing with insolvency (referred to in the USA as bankruptcy for both corporate and non-corporate debtors). These include amendments to Chapter 11 of the US Bankruptcy Code, which is used for the reorganisation of businesses. One such change is increasing the threshold for access to a form of small business reorganisation from $2,725,625 of debt to $7,500,000, reflecting the likelihood of increased debt levels at the present time. In both specific and general terms, it will be of interest to see what further changes countries such as the USA adopt as the crisis continues. 

 

Conclusion

At both the Scottish and UK levels, the coronavirus crisis is already changing the insolvency law landscape, directly through the reform of insolvency law itself but also as an indirect consequence of other measures. The details of the UK corporate insolvency law changes are still to be revealed but the provisions suspending the application of wrongful trading laws, in particular, could be helpfully influenced by reforms in other jurisdictions. There is the possibility of further legislative responses to the coronavirus pandemic and, once again, other systems may offer useful examples of ways to manage debt and insolvency in the wake of the crisis.

Perhaps understandably, the focus of the reforms in the UK (and elsewhere) has so far been on providing protection to debtors, but some thought requires to be given to the position of creditors, who, if unpaid and unable to exercise remedies, may themselves become victims of the crisis. This could create a domino effect with significant negative consequences for the wider economy.

Published by School of Law, University of Aberdeen

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