Political,regulatory competition and the U.K. debt-restructuring regime at the crossroads

Abstract

This article analyses CIGA 2020 reforms to the U.K. insolvency and debt-restructuring regimes, particularly, the new part 26A restructuring plan, the creditor cross-class cramdown and the new standalone moratorium and their impact on the U.K. insolvency and debt-restructuring landscape. The article contends that these permanent changes were not needed immediately, in the aftermath of Brexit and COVID-19 experiences. Rather, temporary time-limited changes would have been ideal, followed by an impact assessment that would inform desired course of reforms, rather than fast-tracked reforms that may have been driven by political and regulatory competition. The article further argues that these CIGA 2020 reforms could instigate a policy shift, from a pro-creditor to a pro-debtor restructuring regime, that questions the United Kingdom's overall policy objective moving forward.

Introduction

The United Kingdom's (UK) ¹ exit from the European Union (EU), which became to be known as Brexit, precipitated the drive to ensure that it remained one of the leading destinations for insolvency filing and debt restructuring, and at the same time, maintain its ability to compete with key EU and other international competitors, such as the United States of America (US) and Singapore. ² As reported by the New Financial ³ in October 2019, ⁴ shortly after Brexit, 332 firms had relocated their headquarters or main offices, staff and assets outside the UK with 310 firms choosing post-Brexit specific business hubs for their EU business operations. ⁵ The UK sought reforms that not only responded to these challenges, but also, would ensure that the introduced reforms matched international trends, such as those introduced under the EU Preventive Restructuring Directive ⁶ across EU member states that provided legislative and policy competition to the UK. ⁷

Prior to the Brexit referendum in 2016, the U.K. government had undertaken two consultations, in 2016, ⁸ and 2018, ⁹ in a bid to reform its insolvency and debt-restructuring laws and processes. This was following concerns that many of its basic insolvency laws and debt-restructuring procedures had remained unchanged since 2004 and through the global financial crisis of 2007/2008. ¹⁰ On the other hand, the outbreak of COVID-19 in December 2019, and its exigencies had precipitated the need for a rapid response from the U.K. government. The 2016 and 2018 consultations were fast-tracked and debated by parliament in a bid to foster legislative changes to guide and support businesses during the COVID-19 crisis. ¹¹

On 20 May 2020, the Corporate Insolvency and Governance Bill was published, ¹² and was enacted into the Corporate Insolvency and Governance Act 2020 (CIGA 2020) ¹³ on 25 June 2020, implementing both temporary (time-limited) changes, ¹⁴ as a response to COVID-19, and permanent changes to the U.K. insolvency and debt-restructuring laws and processes. Key changes included inter alia, the new part 26A restructuring plan (under the Companies Act 2006), ¹⁵ with the creditor cross-class cramdown mechanism, ¹⁶ a new standalone moratorium, ¹⁷ and a ban on ipso facto termination clauses. ¹⁸ However, due to the scope of this article, only three permanent changes; the new part 26A restructuring plan with creditor cross-class cramdown, and the new standalone moratorium are analysed to explore whether indeed, these permanent changes were desired in the aftermath of Brexit and COVID-19, their perceived shortcomings and whether a more balanced approached to legislative reform was desirable in implementing the CIGA 2020 reforms.

This article analyses CIGA 2020 reforms to the U.K. insolvency and debt-restructuring regimes, particularly, the new part 26A restructuring plan, the creditor cross-class cramdown and the new standalone moratorium and their impact on the U.K. insolvency and debt-restructuring landscape. The article contends that these permanent changes were not needed immediately, in the aftermath of Brexit and COVID-19 experiences. Rather, temporary time-limited changes would have been ideal, followed by an impact assessment that would inform the desired course of reforms, rather than fast-tracked reforms that may have been driven by political and regulatory competition. The article further argues that the CIGA 2020 reforms may instigate a policy shift, to the UK's insolvency and debt-restructuring characterisation from a pro-creditor to a pro-debtor restructuring regime, that may question the UK's overall policy objective moving forward.

CIGA 2020 reforms analysed

The new restructuring plan under part 26A was introduced to be utilised by companies that are experiencing or are likely to experience financial difficulties that could affect their ability to continue operating as a going concern. ¹⁹ This new restructuring plan is somewhat like the already existing scheme of arrangement procedure under Part 26 of the Companies Act 2006. ²⁰ However, the key most notable differences between these two procedures are the absence of the requirement on the debtor to demonstrate insolvency but to provide evidence of actual or likely financial difficulties under the new Part 26A restructuring plan. The second difference is that the new Part 26A restructuring plan comes with new provisions on creditor ‘cross-class cram-down’ (discussed below) which wasn’t available to debtors under the old restructuring plan under Part 26 of the Companies Act 2006. ²¹

However, the new restructuring plan is a legal construct, that is, it is created and/or established by law, rather than a contractual workout between the debtor and its creditors. Consequently, it offers the debtor an upper hand in designing and driving the procedure unlike the old scheme of arrangement under Part 26, of the Companies Act 2006 that is purely based on contractual workout between the debtor and the creditors who are divided into classes. ²² The new Part 26A restructuring plan can only be utilised where the debtor has encountered, or is likely to encounter financial difficulties that are affecting, or likely to affect its ability to carry on business as a going concern. ²³

The overall purpose (of the proposed restructuring plan) is either to reduce, prevent, eliminate, or mitigate the impact/effects of the debtor's financial difficulties. ²⁴ Prior to approval of the proposed plan by the court, it ensures that minority creditor protection is undertaken such that approving the debtor's restructuring plan would be fair and equitable to the minority (dissenting) creditors, otherwise, it may exercise its discretion to decline to sanction the proposed plan. ²⁵ The new Part 26A restructuring plan requires a simple 75% majority (in value), ²⁶ to be approved whereas in other creditor compromises, such as a the Part 26 scheme of arrangement, other activities, such as a head count has to be undertaken. ²⁷

In addition, the new Part 26A restructuring plan comes with the ability by the debtor to utilise a creditor cross-class cramdown. The creditor cross-class cramdown process refers to the imposition of a restructuring plan on dissenting creditors of one or more classes of affected creditors including both secured and unsecured creditors, provided at least one other class of affected creditors has accepted the plan. ²⁸ This applies to creditors within a single class and, the cramdown of whole classes of creditors. ²⁹ This provides an inherent advantage to the debtor to address ‘hold-out’ problems that may slow, if not, totally impede the debtor's restructuring plan subject to minority creditor protection. ³⁰

The other key change brought by CIGA 2020 is the new standalone moratorium to be utilised by debtor companies in financial distress to facilitate their debt-restructuring endeavours. ³¹ Prior to the passage of CIGA 2020, debtors could only utilise an automatic moratorium from creditor actions where administration proceedings, which were insolvency proceedings, other than debt-restructuring proceedings were initiated. ³² The other form of moratorium was the so-called (small company moratorium) available to small companies undergoing company voluntary arrangement proceedings but have since been abolished by CIGA 2020. ³³

Like the new part 26A restructuring plan, the new standalone is initiated by the current management/directors who have the power to adopt it to offer protection from creditor enforcement actions as they execute their debt-restructuring plan. ³⁴ Apart from protection from creditor enforcement of their debts, the moratorium can also be used to constrain creditors from initiating insolvency proceedings against the debtor to recover their interests, ³⁵ and the debtor also enjoys some payment holidays from pre-moratorium debts courtesy of the moratorium. ³⁶

Provided the debtor company meets the eligibility criteria, that is, it is experiencing, or likely to experience or to be affected by insolvency, ³⁷ directors can apply to utilise a moratorium, ³⁸ for an initial period of 20 business days, ³⁹ during which, they remain in charge and control of the business operations. ⁴⁰ Directors would then work alongside a licenced insolvency practitioner/monitor (who also serves as an officer of the court), ⁴¹ to monitor the company's affairs for the purpose of forming a view as to whether, it remains likely that the moratorium will result in the rescue of the company as a going concern. ⁴² The initial moratorium period of 20 business days can be extended by directors for a further 20 business days with or without any creditor consent, ⁴³ or extended for up to 12 months with consent of pre-moratorium creditors or the court after the first 15 business days. ⁴⁴

Nevertheless, the policy objectives underlying CIGA 2020 reforms was to ensure that previously identified and/or perceived weaknesses with the UK's insolvency and debt-restructuring laws and processes could be fixed and to reinforce the UK's position as one of the leading global players in the insolvency and debt-restructuring arena. ⁴⁵ However, whether the passage of CIGA 2020 is to be heralded as a needed timely intervention in the aftermath of Brexit and COVID-19 remains a question subject to varying debates. ⁴⁶

CIGA 2020 reforms – a timely or superfluous intervention?

Arguably, legislative reforms were needed at some point (following Brexit and COVID-19) to align the UK with international trends, in line with the perceived weaknesses following the 2016 and 2018 consultations. However, CIGA 2020 and its introduced reforms were fast-tracked to respond to crises broadly exacerbated by Brexit and COVID-19 exigencies in an unusual manner. The usual process of legislative reforms mainly through parliamentary scrutiny and consideration of opinions and/or recommendations from interest groups were not afforded adequate audience due to time constraints (the need to respond to COVID 19-induced exigencies). ⁴⁷ From this perspective, these reforms may be perceived as being driven by both political (Brexit) and regulatory competition to respond and match international competitors that had recently made changes to their corporate insolvency and debt-restructuring regimes by introducing similar mechanisms like those introduced by CIGA 2020. ⁴⁸

Rather than fast-tracking political and competition-driven changes, the UK could, for example, have opted for short-term temporary measures to deal with Brexit and COVID-19 exigencies, remain competitive as an international debt-restructuring hub and consider permanent changes after carefully analysing market and competitive international trends. For example, during COVID-19, the UK introduced temporary time-limited measures that supported its companies to navigate the threat of mass business failures at the time. This was through temporary suspension of liability on company directors for wrongful trading (between 1 March 2020–30 September 2020, and 26 November 2020–30 April 2021) pursuant to CIGA 2020 ⁴⁹ and the Corporate Insolvency and Governance Act 2020 (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020. This was to ensure that company directors did not take irrational business decisions to file unnecessary insolvency proceeding during the COVID-19 crisis period in fear of potential wrongful trading liabilities. ⁵⁰

This was timely and advantageous to companies as they navigated the tides of economic and financial instabilities exacerbated by both Brexit and COVID-19. ⁵¹ It is therefore, the argument that rather than rolling out permanent CIGA 2020 changes in the immediate aftermath of Brexit and COVID-19, temporary measures followed by an impact assessment and/or review to inform future directions would have been desirable. ⁵² This approach was debated by parliament but robustly rejected by the government on the basis that the changes to English insolvency and restructuring laws and processes had been the subject of extensive consultations in 2016 ⁵³ and 2018 ⁵⁴ and it was the opportune moment to effect the changes. ⁵⁵

However, whether indeed, this was the opportune moment for these changes remain a contentious issue. ⁵⁶ Some stakeholders were of the opinion that pre-CIGA 2020 insolvency law processes and procedures remained competitive enough to be adapted to emerging international trends and challenges. ⁵⁷ However, the U.K. Government was not moved by these opinions and opted for the introduction of CIGA 2020 as being necessary. ⁵⁸ Nevertheless, there was a need to take time prior to the passage of CIGA 2020 to evaluate how existing debt-restructuring and rescue procedures, such as administration and the scheme of arrangement would fare alongside the new provisions established by CIGA 2020. This is especially, with the new Part 26A restructuring plan (with similar but non-identical features to the part 26 Scheme of Arrangement) and the new standalone moratorium (considering the already existing moratorium attached to the administration procedure). ⁵⁹

Questions, such as what form of advantage(s) the new standalone moratorium would have over the administration moratorium or a pre-packaged administration business sale and the intended policy objectives moving forward, needed broader deliberations. Some of these concerns were explored during the House of Lords debate of the CIGA 2020 Bill but were not broadly scrutinised. ⁶⁰ For example, the answer to the question on the intended relationship between the new standalone moratorium and pre-packaged administration business sales and how these two procedures could be approached was that the former was not to be used as a precursor to the latter, with no detailed justifications given. ⁶¹

The oversight and inadequate scrutiny of the intended legislative reforms by the U.K. government have meant that some of the introduced reforms have yet to achieve the intended policy objectives – a position that would arguably have been avoided had the notion of permanent CIGA 2020 reforms been approached with full and/or adequate scrutiny. A look at the approach taken by the Netherlands in its reforms to its insolvency and debt-restructuring law would perhaps, support the contention that the CIGA 2020 reforms were not fully or properly thought through.

Dutch WHOA

On 1 January 2021, the Netherlands introduced the Act on Court Confirmation of Extrajudicial Restructuring (Planswet homologatie onderhands akkord (WHOA)) into its legislative framework. The WHOA is a mainly out-of-court restructuring procedure available to companies experiencing insolvency or those in financial distress that is binding on all dissenting creditors and/or class creditors, upon application by the debtor, creditor or shareholder. ⁶²

Unlike the U.K. Part 26A restructuring plan, the WHOA comes with a non-automatic stay (moratorium) on creditor enforcement actions that is only availed after application by the debtor or restructuring expert. ⁶³ The WHOA restructuring plan can be prepared by the debtor or restructuring expert and offered as a public or private procedure. A public procedure is openly conducted and is published in both the Insolvency Register and in the Trade Register of the Dutch Chamber of Commerce, ⁶⁴ while a private procedure is conducted as a closed session. ⁶⁵ The two choices provide flexibility and freedom to the debtor or restructuring expert to design and execute the desired plan. The WHOA could be adopted to balance both debtors’ and creditors’ interests as it can be initiated by creditors as well as debtors and it equips creditors powers to appoint a restructuring expert to prepare the restructuring plan. ⁶⁶

Prior to the passage of WHOA in 2021, the Netherlands lacked a scheme-like restructuring procedure for companies in financial distress as existing procedures could only bind general unsecured creditors, but not secured or preferential creditors and shareholders. ⁶⁷ This proved a challenge to Dutch companies as some companies opted for the U.S. Title 11 proceedings or English Part 26 scheme of arrangement to restructure their debts. ⁶⁸ However, the WHOA has to a large extent mitigated these challenges as it provides an attractive tool for Dutch companies in financial distress to restructure their debts locally due to its flexibility and ability to bind certain dissenting class creditors. This is in addition to the possibility that WHOA related agreements and judgements would be recognised in other jurisdictions, such as the EU and the USA under Chapter 15 of the U.S. Bankruptcy Code. ⁶⁹

Therefore, in a quest to design an insolvency framework that would place the Netherlands among the top competitive places for debt restructuring, the Dutch legislators drew inspiration from both Title 11 of the U.S. Bankruptcy Code and the U.K. Part 26 Scheme but then combined the best elements from both frameworks into their framework – the WHOA. Elements, such as creditor cramdown and stay (moratorium) and setting up a pool of specialised judges (among others) were introduced into the WHOA to ensure that intended policy objectives are met. This is an approach that the UK would have taken enroute the passage of CIGA 2020 and its intended reforms.

For example, although the WHOA is partially inspired by Title 11 of the U.S. Bankruptcy Code and U.K. Scheme of Arrangement under Part 26 of the Companies Act 2006, the legislators were able to leave out certain provisions from both jurisdictions they thought would not fit local context and/or serve intended policy objectives. For instance, the stay introduced by the WHOA is not granted automatically upon filing for bankruptcy proceedings as is the case under Title 11 and the U.K. Part 26A restructuring plan but only triggered upon request by the debtor. This was to ensure flexibility, especially, in regard to the protection of both creditor and debtor interests during debt restructurings.

Perceived shortcomings

As discussed above, CIGA 2020 reforms were fast-tracked with less parliamentary scrutiny and consideration of opinions and/or recommendations from interest groups due to time constraints. ⁷⁰ As a corollary, the U.K. Government promised a review of the CIGA 2020 reforms and their impact on the intended objectives within three years of commencement. Two reviews were subsequently undertaken in March and November 2022. ⁷¹ Interestingly, the Final Review acknowledged that although some of the policy objectives were being met, especially, under the new Part 26A restructuring regime, other objectives, such as those under the new standalone moratorium were not. ⁷²

In relation to the standalone moratorium, the Final Review Report specifically reported that the policy objective of the new standalone moratorium as envisaged was not being fully met. ⁷³ The standalone moratorium had not been fully utilised by insolvency practitioners. Regrettably, insolvency practitioners felt that the new standalone moratorium was ineffective as a stay tool for providing a breathing space within which impacted companies could explore and implement rescue objectives and/or agree objectives with creditors. ⁷⁴ Two years on following the Final Evaluation Report in November 2022, only one notable case involving the new standalone moratorium has been reported. ⁷⁵ One of the prominent insolvency scholars, Professor Patterson opined that the new standalone moratorium would be seen as a negative signal by invested stakeholders, such as suppliers upon restructuring, and may impact confidence in the debtor's restructuring objectives. ⁷⁶

This is in addition to the contention that the new standalone moratorium is primarily beneficial to the debtor company's restructuring endeavours since it stays potential creditor enforcement rights. ⁷⁷ This raises questions as to whether the new standalone moratorium would have any incremental impact to the objectives of preventive restructuring as per the intended policy objectives underlying its introduction in the CIGA 2020 in the years to come, or another form of legislative tools introduced in a wave of ‘mid-crisis restructuring law reform’ as posited by Professor van Zwieten. ⁷⁸

Moreover, pre-moratorium debts, such as debts and liabilities arising under a contract or other instruments involving financial services loan agreements may not be subject to a standalone moratorium under what is termed as carve-out for financial services contracts. ⁷⁹ Without the support of such creditors, the debtor company may be unable to file a moratorium which may impact the overall rescue and/or restructuring endeavours. In Re Corbin & King Holding Ltd, ⁸⁰ Sir Alastair Norris observed that the purpose of the exclusion of finance debts from the payment holiday effects of a moratorium was to encourage continued lending to companies who were struggling but is somewhat surprising. ⁸¹ The carve-out provision impacts the flexibility of the new standalone moratorium to be fully utilised by debtors to execute effective restructuring plans as originally intended by CIGA 2020. This concern was also noted in the Final Evaluation Report by Professor Walton and Dr Jacobs where surveyed stakeholders observed that inability of a moratorium to prevent a bank from requiring payment of its debt (including accelerated debt) was one of the major reasons why the standalone moratorium may be of limited use in practice. ⁸²

New Part 26A restructuring plan

Prior to the passage of CIGA 2020, the administration procedure was described as the most effective and successful rescue procedure within English insolvency and debt-restructuring frameworks. ⁸³ The administration procedure was instigated by the Cork Report of 1982, ⁸⁴ and has since inspired many insolvency systems of the world to be based on the U.K. regime. ⁸⁵ Its perceived success may have been attributed to the procedural flexibility of the three hierarchical objectives to be pursued by the appointed insolvency practitioner with the main objective to rescue the company as a going concern for the benefit of the company as a whole. ⁸⁶ The second and third objectives of achieving a better result for the creditors as a whole than would be likely if the company was wound up, ⁸⁷ and realising assets to distribute to creditors according to priority status. ⁸⁸ The appointed administrator has broader scope to devise the purpose of administration based on commercial judgement and significant court oversight. ⁸⁹ The procedure is creditor friendly as it requires the interests of creditors as a whole to be taken into account depending on the circumstances and purpose pursued by the administrator.

On the other hand, the scheme of arrangement under Part 26 of the Companies Act 2006 had made the UK, one of the leading debt-restructuring hubs within Europe due to its unique features. ⁹⁰ This is especially, on the notion that U.K. courts had jurisdiction to sanction a scheme of arrangement if applied for by a company outside the UK provided the company is deemed to have ‘sufficient connection’ with the UK irrespective of where it was incorporated. ⁹¹ However, the introduction of the new Part 26A restructuring plan, although perceived as an incremental procedure to provide more options for companies experiencing or likely to experience financial difficulties to navigate such challenges, it could blur the boundaries between these two as they are somewhat similar, save for some minor differences.

The main difference being the need to demonstrate financial difficulties and/or likelihood of insolvency which is not a requirement under the old scheme of arrangement. In addition, under the original Part 26 scheme of arrangement, dissenting creditors in their entirety, within a class, could not be crammed down like is the case under the new Part 26A restructuring plan. This provides more protection to pre-restructuring creditor rights and re-enforces the position of the scheme of arrangement as one of the UK's most attractive procedure for companies to adopt in restructuring their financial affairs. ⁹²

Moreover, under the scheme of arrangement, creditors’ say is given more protection, especially at the convening stage, to workout issues, such as creditor class composition, creditor legal rights and interests, and those with no genuine economic interest in the company are excluded. ⁹³ At the sanctioning stage hearing, although creditor votes on the scheme will already have taken place, the court ensures that the proposed plan under the scheme is reasonable to all affected creditors such that a reasonable member of the affected class and in their interest, could have voted in favour of the proposed plan, taking issues, such as creditor democracy as paramount. ⁹⁴

Although the court plays a key role in ensuring that the proposed restructuring plan meets the best interest of creditors’ test, the new Part 26A restructuring plan affords the debtor broader discretionary powers in determining the nature and extent of minority creditor protection and the court may put more weight of consideration to the debtor/monitor's opinion on the potential success of the proposed restructuring plan.

In Re DeepOcean I UK Ltd, ⁹⁵ the court held that under a Part 26A restructuring plan, there exists no requirement on the debtor to utilise the proposed plan to rescue the company as a going concern like is the case under administration proceeding. The key requirement is for the debtor's proposed plan to address the financial difficulties impacting the company's ability to carry on its business as a going concern as set out under s.901A of the Companies Act 2006. ⁹⁶ Therefore, in this case, Trower J made an order approving the creditor cross-class cram down despite only 64.6% of unsecured creditors voting in favour of the plan on the basis that the unsecured creditors failed to provide evidence that they would be worse off under the proposed plan than under the relevant alternative, in this case, liquidation.

Although Trower J considered factors, such as the overall support for the restructuring plan across all creditor classes; fair representation of dissenting creditor classes; existence of any collateral interests that influenced voting and the treatment of creditors in different classes – (horizontal comparability) in exercising his discretion, it remains questionable, whether such a plan would have been approved prior to CIGA 2020. This further reaffirms the lack of a clear approach on how the cross-class cram down is to be used to achieve a positive restructuring outcome post-CIGA 2020. ⁹⁷

The concern is that the threshold used by the debtor to determine the creditors/members that have or do not have genuine economic interest in the company and are excluded from participation in the negotiations and sanctioning of the restructuring plan remains questionable. ⁹⁸ The scope within which the debtor determines which of the creditors or equity holders to be involved, and based on valuation of the creditors ‘within’ or ‘out of the money’ is currently unclear. There is no outlined valuation threshold to determine exactly, the factors upon which valuation is to be based, or evidence required to indicate whether a creditor indeed, has genuine economic interest in the company, and therefore, involved. This even gets more complicated where different class creditors with different rights and interests are affected by the proposed Part 26A restructuring plan. ⁹⁹

Moreover, the notion of ‘genuine economic interest’ would entail the consideration of fairness as not all creditor interests are similar or equal, and some may not be considered in an insolvency or debt-restructuring setting. The financial failure of a company impacts creditors differently. Some guidance on the key aspects such as fairness and cramdown of creditors into classes has been previously given by the courts in cases, such as Re Telewest Communication Plc (No.1), ¹⁰⁰ and recently, in Re Sunbird Business Services Ltd, ¹⁰¹ and Virgin Atlantic Airways, ¹⁰² respectively. However, the guidance is not conclusive.

The new Part 26A restructuring plan is a relative new procedure introduced by CIGA 2020 and not a great deal of caselaw has come through courts upon which jurisprudential key issues, such as valuation, fairness and determination of genuine economic interests could be drawn to fully attribute the ‘exact’ threshold and this will take time. ¹⁰³ The explanatory note accompanying CIGA 2020 indicates that the commonality between the new part 26A restructuring plan and the scheme of arrangement should allow courts to draw on the existing body of case law where appropriate. ¹⁰⁴ However, under the new part 26A restructuring plan there are no set criteria that the plan should cover.

Therefore, it remains a concern that the ability by the debtor to cramdown creditors under the new Part 26A restructuring plan and ability to constrict potential creditor actions through a restructuring moratorium may be used selfishly to write-off or shake-off liabilities that the debtor company would otherwise meet or settle. This is in addition to the debtor being able to utilise the moratorium to prop-up a non-viable company that is not worthy of rescue. ¹⁰⁵ Although the intention of the CIGA 2020 mechanisms was the need to provide the debtor with a broader pool of resources to deal with financial difficulties or distress, this may have profound implications and consequences to a range of stakeholders, including the company itself, employees, creditors, and the economy at large. ¹⁰⁶ Consequently, this may impact the UK's position as a global player in debt-restructuring market place by opening the door to jurisdictional forum shopping ¹⁰⁷ for debt restructuring, especially in Europe and elsewhere. ¹⁰⁸

Creditor cross-class cramdown

In its consultation in May 2016, the UK government, under the Insolvency Service, believed that ‘developing a more sophisticated restructuring process with the ability to cramdown creditors and processes may facilitate more restructurings, and the subsequent survival of the corporate entity as a going concern.’ ¹⁰⁹ This is a shift from the traditional approach to class creditors’ rights within the U.K. insolvency and debt-restructuring framework. This process is an import from Title 11 of the U.S. Code and later adopted by the UK under CIGA 2020.

In the US, however, creditors undergoing a bankruptcy reorganisation proceeding and are subject to a cramdown are protected by the best interest of creditors’ test, ¹¹⁰ guided by conditions set out in section 1129 of Title 11 of the U.S. Code. This is to ensure that the proposed plan meets the principles of fairness and equity, such that creditors with similar rights and interests are treated comparably and fairly. ¹¹¹

In addition, the best interest of creditors’ test/principle is supplemented by the absolute priority principle. The absolute priority principle is a system of priority set by Title 11 of the U.S. Code, that determines and guides the order in which bankruptcy courts distribute assets of the debtor's bankruptcy estate in accordance with priority rules. ¹¹² This means that in principle, shareholders cannot be paid ahead of creditors without their consent and/or unless, they are providing some form of new or additional value. Otherwise, secured creditors always rank in priority, ¹¹³ and the court may decline to approve a bankruptcy reorganisation plan that would violate the creditor class priority rights. ¹¹⁴

The UK, however, did not adopt this approach in its CIGA 2020 reforms, especially under the new Part 26A restructuring plan with creditor cross-clam cramdown. This raises the question as to whether, CIGA changes, especially the ability for a debtor to utilise a creditor cross-class cramdown to impose a debt-restructuring plan on dissenting creditors were needed at the time, or merely, a responsive reaction premised on political and regulatory competition.

The concern is that Title 11 of the U.S. Code, from which these mechanisms are borrowed is characteristically known for being a debtor-friendly regime, under what is has become to be known as a debtor-in-possession model. ¹¹⁵ This was not a form of characterisation of the U.K. regime prior to the CIGA 2020 reforms, despite CIGA 2020 reforms, especially the new part 26 restructuring plan embodying a debtor in possession (DIP) norm like is currently the position in the US. The DIP is defined as the ‘same’ person as a pre-petition debtor unless a trustee is appointed. ¹¹⁶ The DIP is, therefore, existing management/directors of the debtor before filing for bankruptcy reorganisation proceeding, ¹¹⁷ and it is traceable to the U.S. bankruptcy reorganisation of the equity railroad receiverships of the 19th and early 20th centuries. ¹¹⁸

Nevertheless, the DIP regime is a relatively new phenomenon in the UK. Prior to the passage of CIGA 2020, there were some iterations of the DIP norm that provided for the debtor to remain in possession of the business during corporate rescue processes, such as a scheme of arrangement, ¹¹⁹ and company voluntary agreements. ¹²⁰ Under the new Part 26A restructuring plan the current management (directors) remain in control and work alongside the appointed insolvency practitioner in executing the proposed debt-restructuring plan with aid of tools, such as creditor cross-class cramdown and standalone moratorium. ¹²¹

Apparently, the debtor is afforded broader powers to undertake business actions, such as making amendments and/or rejection of executory contracts, changes to absolute priority rules, obtaining post-petition financing, etc., in the ordinary course of business, to facilitate the restructuring plan. ¹²² Proponents of the DIP model attribute key advantages to it. One of such advantages is the retention of the debtor's existing management in control and management of the business. ¹²³ This has the advantage that existing directors’ knowledge, expertise, and network of business contacts concerning the debtor's business and financial affairs is uninterrupted. This may mean that directors may undertake timely and voluntary initiation of debt-restructuring proceedings, which may be beneficial to the debtor's rescue prospects. ¹²⁴

However, these CIGA 2020 reforms, especially the new Part 26A restructuring plan, creditor cramdown and new standalone moratorium were inspired by Title 11 of the U.S. Bankruptcy Code and introduced into the UK's regime (with some minor modifications in some instances). Yet, Title 11 of the U.S. Bankruptcy Code characteristically adopts a DIP Model unlike the position in the UK prior to CIGA 2020 reforms. As these new reforms are debtor-driven, that is, adopting a DIP norm, this may lead to the UK regime being characterised as a debtor-friendly regime, a move away from its known characterisation as a creditor-friendly regime prior to CIGA 2020 reforms.

Regime categorisation as either debtor-friendly or creditor friendly plays a big role, not only in influencing decision-making by debtors seeking a destination for business domicile but also, for debt restructuring or insolvency filing due to jurisdictional competition. ¹²⁵ Regime categorisation can also shape legal development, direction and policy objectives within an insolvency regime. ¹²⁶ It further informs the basis upon which certain insolvency and debt-restructuring policy objectives are advanced by that particular jurisdiction/regime. For example, determining whether creditors’ interests should be made prominent against those of debtors.

An analysis of some of the new tools introduced by CIGA 2020, especially, the new Part 26A restructuring plan, creditor cross-class cramdown and the standalone moratorium supports the argument that the UK's insolvency and debt-restructuring landscape is enroute to a so-called DIP model, ¹²⁷ which again, leads to the question of whether, this is the route that the U.K. government sought to take in their policies underlying the CIGA 2020 reforms, or an outcome of fast-tracked legislative reforms absent adequate due diligence.

Conclusion

In every sovereign jurisdiction, the term debt restructuring does not always come with good news to all creditors invested with the debtor company. It is a message to creditors and equity holders alike, that the company's financial health needs attention. This is because debt restructuring involves key aspects, such as tempering with already existing pre-insolvency creditor interests, especially, the priority of enforcement upon default. ¹²⁸ Moreover, preventive restructuring proceedings, being mainly out of court-initiated (although the in-court route is also available), equip the debtor with more bargaining power in a bid to achieve the desired outcome, which may come at the expense of some creditors and other equity holders where possible. ¹²⁹

This is why, an efficient insolvency and/or debt-restructuring regime ought to be designed by sovereign states to ensure a balanced approach to protecting both debtors’ and creditors’ interests once debt restructuring and/or insolvency proceedings are initiated. The core function of debt restructuring is to direct and facilitate a new arrangement between the debtor and existing creditors, especially, those that are still keen to remain invested in the company (despite it being in financial distress). The rationale is to reach a comprise/new arrangement as to their future rights and interests with the debtor. This may involve the debtor, taking necessary constraints against the so-called ‘anticommons’ problems, ¹³⁰ from dissenting creditors, both individual and class creditor rights to ensure that the new arrangement with creditors is ratified. ¹³¹

Although legal reform is needed to align with several factors, such as market trends, economic forecasts, political and economic exigencies, due diligence ought to be taken to ensure that changes ensuing legal reforms fit local contexts and practices. ¹³² This is because, legal concepts may call for different transposition approaches which may have a knock-on effect to the already existing legal framework. ¹³³ If approached otherwise, this may cause procedural concerns as to contextual fit and the blurring of the proper or core function of the UK's insolvency and debt-restructuring regimes. ¹³⁴

It may be noted that an unfavourable insolvency framework is one of the identified factors underscoring the efficiency and effective of a debt-restructuring regime and/or jurisdiction. ¹³⁵ The concern is that CIGA 2020 reforms were fast-tracked without adequate legislative scrutiny and impact assessment. As a consequence, the new reforms have instigated new norms, such as creditor cross-class cramdown imposing a restructuring plan on dissenting creditors and a DIP norm within the UK's insolvency and debt-restructuring landscape which may underscore the UK regime's categorisation as a top debt-restructuring hub in Europe, at least, in the short term until the actual parameters of the new mechanisms, and a body of case law comes through courts to fully attribute the UK's position.