UK Insolvency Restrictions – Hoping for the Best but Preparing for the Worst?

With the UK’s insolvency restrictions extended once again, Kroll looks to the practical implications of enforcement and recovery when they are finally lifted.

As the country went into lockdown from March 2020, the government was rightly concerned with ensuring that support measures reached people and businesses in need as quickly as possible. This led to an unprecedented level of funds being made available using new schemes and mechanisms.

Moratoriums on enforcement action included protection for directors against liabilities for wrongful trading, protection from creditors issuing statutory demands and restrictions on issuing winding up petitions. Furthermore, landlords have been unable to enforce a right of entry or forfeiture for non-payment of rent in certain business tenancies. These measures have resulted in a clear decline of new personal and corporate insolvencies. Compulsory liquidations (those appointed by the court) were down by more than a half in the 12 months following the introduction of the government’s temporary schemes. Some of these restrictions have been extended again to prevent a wave of enforcement actions damaging the recovery of the economy.

Creditors have been unable to present a winding-up petition for 15 months where a business can demonstrate its financial distress is related to COVID-19. This has been delayed again until September 2021. In practical terms, this means that the provisions of Section 127 of the Insolvency Act have not been triggered in terms of void dispositions following the presentation of the petition. This will be a significant factor if these companies eventually enter an insolvency process. There has been no court sanctioning via validation orders, so the spotlight will be on the appropriateness of certain payments, with liquidators seeking recovery of any inappropriate dispositions through antecedent transaction provisions.

Directors were protected from personal liability associated with wrongful trading claims from March 1, 2020, however at the time of writing, this is expected to end on June 30, 2021. Consequently, liquidators will consider potential misfeasance and fraudulent trading claims from March 1, 2020 to June 30, 2021 and wrongful trading claims from July 1, 2021 onwards if there is a worsening of the company’s position. 

Concerns center around the number of winding up petitions that are stock piled ready to go and how this will be managed by the courts. Will this be an issue, or will the backlog be rendered redundant with large numbers of directors finally mobilizing to place the company into creditors voluntary liquidation mindful of the withdrawal of the wrongful trading reprieve and ultimately perceiving voluntary liquidation to facilitate a softer landing?

The attitude of creditors will be key in determining whether compulsory petitions continue, or whether they allow a voluntary process but with an active influence on the choice of liquidator.

As a means of avoiding abuse, we may also see creditors increasingly using provisional liquidators to seek immediate appointment on cases where there is a general view that the directors are seeking to dissipate assets. A provisional appointment by the court may provide creditors with the comfort that the assets of the company will be protected pending a winding up hearing.

Those companies that have been or will be dissolved will be subject to the scrutiny of the Insolvency Service which will investigate directors of companies who have misused the dissolution process to avoid paying suppliers and other creditors such as HMRC.

The restriction on commercial evictions is to be extended until March 2022. Furthermore, it is predicted that new rules will be put in place to enable the ringfencing of commercial rent arrears accrued during the pandemic, intended to encourage landlords and tenants to reach consensual agreements on repayment plans. Where agreements cannot be reached significant institutional landlords are calling for a legally binding arbitration process to be put in place.

The extension applies to all businesses; however, the new rules will only be available to businesses who have been impacted by closures such as hotels, restaurants and nightclubs. Those businesses that have been able to open since the lifting of restrictions are expected to pay rent. Directors again need to bear this in mind when considering their duties.

James Liddiment who leads the Real Estate Restructuring practice at Kroll says, “With the extension to the ban on commercial evictions until Spring 2022, many landlords will continue to feel cashflow pressures and require prolonged forbearance from their lenders in the interim, particularly for debt service covenants. Lenders have been able to enforce their security throughout the pandemic, often via LPA Receivership, and we continue to see differing trends across the real estate finance spectrum with some lenders, but certainly not all, having an effective self-imposed moratorium on enforcement (albeit with some case exceptions) for reputational reasons. Broadly, we expect the level of property enforcements to remain stable for the remainder of 2021, in part limited by a surprisingly buoyant property market driven by good demand and availability of debt.”

The intervention by the public sector has undoubtedly saved jobs and supported businesses throughout the course of the pandemic. However, given the amount of money involved and the speed in which the funds needed to be provided, there was inevitably a risk that these schemes would fall victim to fraud. In the UK, the National Audit Office (NAO) estimated between GBP 15 billion (bn) and GBP 26 bn in potential losses from fraud and default, although these figures were “highly uncertain ¹.”

This systematic abuse of government support is also likely to be met with criminal investigations, and in many jurisdictions, arrests and prosecutions are already underway to recover funds using criminal restraint and confiscation proceedings.

In addition to large scale organized crime, there will also be misuse and abuse of the schemes by those who they are aimed at. This may include individuals or companies accessing schemes they are not eligible for, misappropriating funds they have received or seeking financial support with no intention to continue trading the business or repaying those funds.

Not only will insolvency practitioners be expected to investigate and report on the conduct of the directors and any potential criminality, there will also be a growing need for them to try to recover the value of any fraudulently obtained funds. Creditors will likely want insolvency practitioners to consider seeking contributions or compensation from the directors for any misfeasance or fraudulent trading; therefore, enhancing realizations and potentially allowing a route to recover funds that would otherwise have been lost from the public purse.

The Insolvency Service has already written to all IP firms advising that, “if it appears that a person has applied fraudulently”² for the government-backed business interruption loan scheme and bounce back loans, “it is the duty of the insolvency practitioner to consider their reporting obligations.

Sanctions will include disqualification from acting as a director for up to 15 years or an order to repay some or all of the money personally in compensation.

The knock-on effect for directors personally is significant. In addition to calls on personal guarantees we are likely to see a significant increase in misfeasance and fraud claims, all seeking to recover value from directors’ personal assets. Joanne Wright who leads the firms Personal Insolvency practice comments, “There is undoubtedly going to be a significant increase in personal insolvency levels, the attitude of creditors will largely dictate whether this is via bankruptcy or the IVA process. Where there is any suggestion of fraud or impropriety then a consensual arrangement is going to be unlikely. Creditors are going to expect to see the full range of investigative powers launched by a trustee in bankruptcy.”

In conclusion, Robert Armstrong who heads the Contentious Insolvency team says, “Directors should still consider their duties when trading and not seek to take advantage of the extended temporary measures at the detriment of their stakeholders as they could face disqualification or claims.”

Now is therefore the time for all business stakeholders to carefully plan for recovery and consider all the options and tools available to them.

Sources
¹ https://www.nao.org.uk/press-release/investigation-into-the-bounce-back-loan-scheme/ 
² https://www.thetimes.co.uk/article/insolvency-firms-must-report-covid-scheme-fraud-rwxn2kbc8