Moratorium

The UK’s Corporate Insolvency and Governance Bill introduces a new moratorium procedure for a company in financial distress: a “debtor-in-possession” process with the aim of facilitating the rescue of a company as a going concern. The Bill is likely to become law in mid-June, so there is limited time for lenders to prepare for its introduction.

The company’s directors will remain in place and continue to run the business with the protection of the moratorium, but under the supervision of a monitor. The intention is to give the company breathing space and prevent creditors (with some exceptions) from pursuing payment or taking enforcement action whilst the company explores its rescue and restructuring options.  The monitor must be a licensed insolvency practitioner and will oversee the moratorium.

The moratorium is freestanding—it is not a gateway to a particular insolvency procedure and may not lead to any insolvency process at all if the company can be rescued during the moratorium, or can come up with a restructuring plan which is accepted by its creditors.

1. Notification: it is entirely possible that the first a secured lender hears of a company entering Moratorium will be when it gets notice from the company after the moratorium has started. The moratorium will usually start as soon as the relevant papers are filed in court.
2. Who picks the Monitor? A secured lender will have no legal power regarding the appointment of a Monitor. The Monitor is required to be a Licensed Insolvency Practitioner, but unlike the selection of administrators, which can be made by the Qualifying Floating Charge Holder (QFCH), the company or its sponsor will select the Monitor. As a result, secured lenders could find themselves dealing with their borrower under the supervision of a monitor who is not on their panel.
3. No steps to enforce security: A QFCH will not be allowed to crystalize any floating charge (which would normally have the effect of preventing the company from selling the assets which are subject to the charge without the lender’s consent).  The QHFC will also be prevented from imposing additional restrictions on dealing with floating charge assets.  These rights are suspended until the end of the Moratorium. The legislation as currently drafted is intended to protect a floating chargeholder and this may actually put them in a better place than if the relevant assets were realised by an administrator where the return would be diluted by preferential creditors and the prescribed part.
4. A company in a Moratorium can continue to deal with Floating Charge assets on the same basis as before the start of the Moratorium. Although the lender will continue to have a floating security interest in the Debts arising out of sale of Inventory this means that the receivables generated by normal trading in the Moratorium will probably create funding available for the company to use in the Moratorium.  However, if the agreement with the lender is a debt purchase or receivables assignment rather than a loan against security then the lender will find itself in a better position because those receivables will continue to be subject to the purchase mechanism in the agreement. One point to note here is that there is very limited recharacterization risk in the UK: a receivables purchase or assignment mechanism is unlikely to be recharacterized as a loan against security. A lender against a fixed charge on receivables may not be able to retain those receipts and apply them against the loan balance in the Moratorium (even in respect of pre-Moratorium trading)
5. How will the Inventory which the company sells be accounted for? A lender will only be able to insist on verification/monitoring of Inventory if the finance documents provide for such a right.  Often agreements only provide for valuations, appraisals and audits once or twice a year.
6. Legal challenges: Recharacterization may be an area where we will see litigation in the future as a hostile Monitor may be motivated to challenge both the characterization of a receivables purchase arrangement as a loan with security, and also whether assets which are stated to be subject to a fixed charge are in fact only subject to a floating charge because of conditioned consents to deal with the assets set out in the relevant credit agreement.

We may also see challenges around valuation of assets which the company wants to sell given the new right for the company in moratorium to apply to court to have fixed charge assets sold to support the rescue as a going concern and the limitation of the amount payable to the secured creditor as a result of such sale to the market value of the asset, rather than the value of the debt (if greater).

1. Priority of Moratorium expenses: Generally speaking any debt finance liabilities which fall due during the moratorium are given a super-priority, lenders need to be aware that if the rescue fails and the company goes into administration (within 12 weeks), then supplier and wage creditors incurred during the moratorium period have a priority over the lender’s liabilities. This expense ranking will be of particular relevance to a lender who may be considering DIP financing.

We have detailed below actions lenders may wish to consider in preparation for the new legislation.

It is open to secured lenders now to include contractual mitigants in their agreements. For example, the lender could include a requirement to consult on the identity of a Monitor and include an express draw stop event which would arise on appointment without such consultation. The lender could also make any deferral of liabilities conditional on no moratorium being created. Although the only remedy would be a claim for breach of contract, most lenders and borrowers agree such commitments in good faith and would be expected to comply with them.

 It will be prudent to include a specific additional right to carry out valuations on the commencement of a Moratorium.  This will also enable a lender to determine values which may be required if court proceeding follow to allow for fixed charge assets (which would usually include larger equipment, intellectual property and real property) to be sold by the borrower to assist in its rescue as a going concern.

It would be good operational practice to conduct a collateral audit as soon as a lender receives notice of a borrower entering into a Moratorium to confirm verify and validate the value of the collateral and specifically deal with cut off issues in respect of pre- and post-moratorium receivables.

Additionally, lenders may wish to make sure that their security in respect of receivables is being perfected in that proceeds of sale are being received into a designated account (lockbox or trust account) to avoid potential recharacterization risk. This is something that can be checked at audit.

Lenders providing a loan against receivables may wish to consider converting to a receivables purchase arrangement, which will enable the lender to remain remote from the moratorium process, if they so choose, and also provide the added advantage of being the beneficiary of any receivables generated during the Moratorium as the collateral would continue to vest in them.

SFNet will be running a Webinar on UK Insolvency Reform, what Secured Lenders need to know which will include the Authors and other experts on June 10 at 11 AM ET.)