This therefore triggers the consideration whether the time has come for a re-think of our insolvency culture and consider alternatives such as the US Chapter 11 Bankruptcy Code or UK restructure plan to help economies and businesses re-build as a result of the formidable financial crisis which the COVID-19 has brought about in its wake.
We have addressed the substantive requirements of a statutory demand, the availability of a statutory remedy to a debtor to apply to the Court to set aside a statutory demand, the Court’s approach on the issue and the timelines involved in our EAlert of 17 August 2020. Kindly refer to the link here.
TIME FOR A CHANGE OF BANKRUPTCY CULTURE?
Clearly, the advent of what may be termed as the COVID-19 era has compelled the acceptance that we are moving to a ‘new normal’ of which one of the components is the culture change to the conduct of business across the globe.
The UK Perspective – Rescue Plan 2020
In 2020, the United Kingdom introduced a restructure plan (‘RP’) under the Corporate Insolvency and Governance Act 2020 through section 26A of the Companies Act 2006.
The RP is not a formal insolvency process. It is part of a corporate restructuring process available to a company facing financial difficulties which could potentially adversely affect its ability to continue as a going concern. It is thus available both when a company is solvent and insolvent. Such a company may come forward with a RP so as to restructure its affairs, whether as a compromise or as an arrangement with its creditors and members.
Importantly, the RP is not mandatory and, it builds on the existing scheme of arrangement under the Companies Act 2006 instead of replacing it such that the scheme of arrangement still remains an option to companies which wish to restructure. The RP innovates from the existing scheme of arrangement in that (i) it does not require financial difficulty threshold conditions for a scheme of arrangement and, (ii) it empowers a court to support companies with an otherwise viable business which are struggling with debts by approving a plan which consists of a cross-class cram-down binding on classes of dissenting creditors and members instead of just minorities from a class.
Furthermore, inasmuch as the court is an integral part of the restructuring plan, this ensures that every point of view will have an official hearing at which in order that the court approves the RP, the court must take the view that it is just and equitable and fair to creditors in the sense that the out-of-money creditors and equity are not worse off than in the alternative scenario. In the event that there are a large number of dissenting creditors, it is unlikely that the court will go against their wishes.
Admittedly, there are two main downsides to the RP plan. First, it does not provide the protections from creditors available under the company voluntary arrangement scheme (CVA). Secondly, the costs involved remain a deterrent for SMEs such that the perception is that the RP is viable for larger businesses, making a CVA a much better alternative for SMEs.
The USA Perspective – Chapter 11 of the Bankruptcy Code
The RP under section 26A of the Companies Act is believed to have been modelled on Chapter 11 of the US Bankruptcy Code as both equally apply to solvent and insolvent companies and capture the yardstick of fairness, equity and reasonableness, amongst others. However, in contrast with the RP plan, empirical knowledge demonstrates that ‘the vast majority of Chapter 11 petitions are filed by small businesses’ and that ‘[a] very small number of Chapter 11 cases concern large corporations.’
A Chapter 11 filing is a ‘reorganisation’ procedure with an underlying policy of avoiding social costs of liquidation and maintaining a company as a going concern. It is intended to be a debtor’s relief as opposed to being a creditors’ remedy and, must include a re-organization plan which (i) classifies the claims against the debtor (ii) describes how each class of creditor will be treated under the plan (iii) how the plan will be carried out and, (iv) must be approved by a majority of the creditors and the Bankruptcy Court.
Despite being slanted towards debtors, a Chapter 11 cram down nevertheless protects objecting creditors through (i) the ‘best interest’ test by which the Bankruptcy Court must be satisfied that, under the plan, each objecting creditor will receive as much as they would in liquidation and (ii) the ’feasibility’ test by which the Bankruptcy Court must be satisfied that the debtor is reasonably likely to be able to perform the promises it makes in the plan.
In brief, a Chapter 11 filing (i) requires an acceptance by each class of impaired claims or equity interests by the prescribed majority vote and, (ii) binds every creditor, equity security holder and general partner of the debtor regardless of whether any of them has accepted the plan. A central feature of the Chapter 11 cram down is that the debtor remains in possession in the sense that it continues its operations and the existing or new management remain in office as opposed to there being an insolvency practitioner who is in office.
Insofar as the Bankruptcy Court is concerned, in order that it approves a cram down plan, the debtor must satisfy the following conditions of which Conditions (a) and (b) are fundamental:
- the plan is fair and equitable in the sense that senior or priority creditors must be paid in full prior to junior creditors and that no interest holder may receive or retain property of the estate unless creditors are paid in full or new value is contributed;
- the plan does not unfairly discriminate any class of creditor especially any class which objects to the plan unless there is a justifiable reason for the discrimination;
- the plan must pay each secured creditor the entire value of the asset used to secure the claim or the entire value of the claim, whichever is less;
- the plan pays each claim holder not less than they would have received under a Chapter 7 liquidation; and
- insofar as unsecured creditors are concerned, one of the following must prevail namely in order that the plan is considered to be fair:
- the plan pays each unsecured creditor the entire value of the creditor’s claim;
- owners of the debtor company do not retain any property or interest in the debtor company after reorganisation unless they contribute “new value” to the plan;
- unsecured creditors approve the plan as a class failing which the owners of the debtor corporation cannot retain an interest in the reorganised debtor under the plan unless they contribute “new value” to the plan.
The COVID-19 pandemic has unquestionably impacted every sector of commerce and recovery, albeit slow and uneven, calls for brave decisions in order that we build a resilient economy.
From the perspective of the school of legal realism, the combined results which a statutory demand produces on a debtor’s enterprise together with the Court’s confirmation that it lacks discretion to extend the statutory delay of 14 days does not do ‘justice’ by not giving weight to social context, the facts of each case or public policy when making its determinations.
Within the context of the COVID-19 pandemic, the UK restructuring plan, albeit new, could aid businesses which are still solvent but struggling with debts come forward with a rescue plan so as to restructure its affairs instead of selling the business and which still involves the court’s consent to approve such a plan which in effect consists of a cross-class cram-down binding on classes of dissenting creditors and members.
Alternatively, a US Chapter 11 reorganization plan could be considered as it will classify claims against the debtor, describe how each class of creditor will be treated under the plan, and how the plan will be carried out. The bankruptcy plan generally must be approved by a majority of the creditors and the bankruptcy court.