Significant developments in the UK's insolvency regime: a creditor's perspective

Corporate Insolvency and Governance Act 2020

The coronavirus (COVID-19) pandemic ushered in a much-awaited reform of UK insolvency legislation, in the form of the Corporate Insolvency and Governance Act 2020 (CIGA 2020). 

As its explanatory notes record, the policy objective behind CIGA 2020 is to provide businesses with necessary flexibility and breathing space in the light of the effects of the coronavirus pandemic to maximise their chances of survival. CIGA 2020 sought to achieve that objective through both short and long-term measures. The short-term measures (including restrictions on presenting winding-up petitions) aimed to mitigate the immediate challenges of the pandemic while the longer-term measures seek to afford greater protection to companies at risk of insolvency. 

The longer-term measures that the government had previously consulted on, including a the introduction of a new restructuring plan process, were fast-tracked through Parliament under cover of the coronavirus-responsive legislation — with the original Bill published on 20 May 2020 and becoming law in little over a month. However, their germination period has been much longer: several of the measures are drawn from a 2016 consultation ‘A Review of the Corporate Insolvency Framework’ (see: LNB News 25/05/2016 57) and the 2018 Government response on Insolvency and Corporate Governance (see: LNB News 28/08/2018 74). On any view, the changes introduced by CIGA 2020 represent the most significant insolvency reforms in many years and make the UK insolvency regime more debtor-friendly in certain respects. 

Among the permanent features of the legislation are the introduction of a free-standing moratorium for distressed companies, an extension of the provisions dealing with termination clauses in supply contracts, and the implementation of a new ‘cross-class cram down’ mechanism for court-approved restructuring plans. All of these measures introduce greater flexibility into the insolvency regime for companies in distress and, to varying degrees, are already having an impact on the insolvency disputes landscape. 

In the following sections, we consider some of the key changes from a dispute resolution perspective and, in particular, how those provisions impact distressed companies’ creditors, who will be looking to take steps to protect and maximise their positions in the event of the debtor’s insolvency. 

A new free-standing company moratorium process

CIGA 2020 introduces, as new Part A1 of the Insolvency Act 1986 (IA 1986), a new free-standing moratorium procedure for companies that require a breathing space from creditor action. It can be used, in summary, if (i) the company is, or is likely to become, unable to pay its debts, and (ii) it is likely that the moratorium will allow the company to be rescued as a going concern. The focus here is on rescue of the company, rather than the moratorium being seen simply as a gateway to another insolvency process. The effect of the moratorium is to give the company a ‘payment holiday’ on certain debts and to prevent legal and other enforcement action against the company while the moratorium is in place.

This is intended to be a quick and low-cost procedure. The moratorium is achieved either by filing certain required documents (including statements from the directors and proposed monitor) at court or, in certain situations, by making an application to the court. The company does not have to give prior notification of its intention to enter into a moratorium to any other party.

The moratorium procedure is a ‘debtor-in-possession’ process: the directors of the company remain in control of day-to-day matters while a monitor (a licenced insolvency practitioner who acts as an officer of the court) supervises the process to ensure that in his or her view the rescue of the company continues to be likely to be achievable. The monitor must support the moratorium application or filing with a statement confirming that it is likely the moratorium will result in the rescue of the company as a going concern. 

Distinguishing categories of debt

IA 1986, Part A1 distinguishes between three categories of moratorium debt, which include both ‘pre-moratorium’ and ‘moratorium’ debts. The categories are as follows:

• category 1: pre-moratorium debts without a payment holiday, comprising certain debts which fell due before or during the moratorium by reason of an obligation incurred prior to the moratorium, including: payments for goods and services supplied during the moratorium; rent during the moratorium; and debts and liabilities arising under a financial services-related contract or other instrument

• category 2: pre-moratorium debts with a payment holiday, comprising all other debts which fell due before or during the moratorium by reason of an obligation incurred prior to it 

• category 3: moratorium debts which fall due during or after the moratorium by reason of an obligation incurred during the moratorium

While there is no payment holiday for category 1 and category 3 debts, there is equally no express requirement that the company pay them. In practice, these debts will often be paid because:

• if applying for an extension of the moratorium beyond its initial 20 business day period, which may well be necessary in many cases, the directors must confirm that the category 1 and category 3 debts have been paid; and/or

• the monitor must terminate the moratorium if he/she believes that the company is unable to pay those debts or if the moratorium is no longer likely to result in the rescue of the company as a going concern 

As to category 2 debts, despite the payment holiday, the company can still pay those pre-moratorium debts up to a certain amount with the monitor or court’s consent (which will only be given if the payment will assist in the rescue of the company as a going concern). 

Effect on creditors

The moratorium will last for an initial period of 20 business days, although it can then be extended for a further 20 business days (by the directors alone), for up to a year (by the directors with the consent of certain creditors), or even indefinitely (by the court). 

From a creditor's perspective, the effect of the moratorium is largely similar to an administration moratorium, and provides a number of restrictions on potential actions against the company, including that: 

• insolvency proceedings cannot be started against it (with some limited exceptions, eg at the directors’ initiative);

• security (other than security financial collateral arrangements and collateral security charges) cannot be enforced against it;

• steps cannot be taken to repossess hire purchase goods;

• no litigation or other legal process can be started or continued against it or its property, and

• floating charges cannot be crystallised

It is not all doom and gloom for creditors though. If a moratorium is put in place and in fact moratorium debts (category 3 above) and certain ‘priority’ pre-moratorium debts without a payment holiday (certain debts in category 1 above) are not paid as they ought to be during the moratorium, those debts will be given super-priority in any liquidation or administration of the company which commences within 12 weeks of the end of the moratorium, ranking above everything other than fixed charge debts. 

It is relevant to note that in these new arrangements, there is nothing that prevents a lender from accelerating its loan in accordance with its terms during the moratorium. The accelerated debt will then be a pre-moratorium debt without a payment holiday. Unless the debt can be paid, this may result in the moratorium having to be terminated by the monitor before the moratorium has had a chance to achieve its aim. 

However, in that situation an accelerated lender debt, although it is a pre-moratorium debt without a payment holiday, will not benefit from the super-priority protection referred to above. Any accelerated debt secured only by a floating charge will rank behind not only the administration or liquidation costs and expenses, preferential debts and the prescribed part, but also behind the debts which receive priority as described above. These provisions may cause lenders to think twice before accelerating during a moratorium.

Extension of statutory controls on termination clauses in supply contracts

Typically, many commercial contracts will contain provisions for the automatic termination of a contract, or which give a right to terminate, upon the counterparty entering into an insolvency process (also known as ‘ipso facto’ clauses). 

Prior to 2015, IA 1986, s 233 provided that, where the company has gone into an insolvency process, the provider of ’essential supplies’ could not make it a condition of continued supply that amounts owing by the company prior to the insolvency be paid (although a personal guarantee from the IP could be requested). IA 1986, s 233A was added in 2015 and restricts ipso facto clauses in contracts for essential supplies where the company goes into administration or a CVA (although the contract can still be terminated if the supplier asks the IP for a personal guarantee of amounts incurred by the company following the administration or CVA and the guarantee is not provided within 14 days).

CIGA 2020 significantly expands the scope of the restrictions imposed on the ability to invoke ipso facto clauses upon a counterparty’s insolvency, with the introduction of IA 1986, s 233B. 

While IA 1986, s 233 and IA 1986, s 233A were already significant in that their effect was to interfere with the substantive terms agreed by the parties, these provisions only applied to contracts for the provision of ‘essential supplies’ (including gas, electricity, water, communications services and IT-related services). By contrast, the new IA 1986, s 233B applies to a far broader range of contracts for the supply of goods or services. The provision is triggered where the non-supplier counterparty enters into a ‘relevant insolvency procedure’ —this includes the corporate insolvency procedures under IA 1986, such as the new moratorium process described above, administration and liquidation, as well as the new Part 26A restructuring plan under the Companies Act 2006 (CA 2006) (but not, notably, schemes of arrangement). 

Effect on creditors

Where new IA 1986, s 233B applies, upon the non-supplier counterparty entering into a relevant insolvency procedure, any clause purporting to terminate the supply contract—or granting the supplier a right to do so—is void. If the supplier had a right to terminate the supply or contract due to a pre-insolvency event but did not exercise it, that right is also suspended until the end of the insolvency procedure.

In themselves, those are already wide-ranging protections for the debtor (insolvent) company. But the provisions go further still: a clause which entitles the supplier to ‘do any other thing’ in the event of the counterparty’s insolvency will also be void. That wording is extremely broad; it is not defined in the legislation but would seem capable, for example, of extending to any provisions which permit contract variation or the withholding of supply. 

IA 1986, s 233B imposes substantial limits on what suppliers (creditors) are permitted to do upon the non-supplier counterparty entering into an insolvency procedure—well beyond a simple restriction on termination. Nor is there any exception for termination rights triggered by fraud or a material breach which is not related to insolvency, which seems to extend beyond the policy objectives underpinning the legislation. 

Termination (but, seemingly, not any of the other actions within the scope of the provision) can, however, still take place with consent of the relevant insolvency office-holder or the counterparty, or with the court’s permission where continuation would cause the supplier ‘hardship’ (which is not defined). As a result, where a supplier’s termination right is restricted, we would expect to see greater communication between suppliers and the office-holder with a view to determining whether the insolvent company actually wants the supply to continue. 

A supplier can also continue to exercise its contractual rights (to terminate or ‘do any other thing’) where those rights arise after the counterparty enters into a relevant insolvency procedure (eg non-payment for goods supplied after the counterparty becomes insolvent). Overall, though, this means that unless an exemption applies or the relevant permission to terminate is obtained, a supplier will need to continue to supply the counterparty during the insolvency period unless and until a post-insolvency event gives rise to a (new) termination right. 

In a further example of the expansive effect of the legislation (and like the moratorium procedure above) the application of IA 1986, s 233B is not confined to English, Welsh or Scottish companies, or even to English law-governed contracts; the new provisions can apply to overseas companies where the overseas company enters into one of the specified insolvency procedures in this jurisdiction. For example, overseas companies with a sufficient connection to the UK can use the new restructuring plan and would thus be a subject to a relevant insolvency procedure for the purposes of IA 1986, s 233B. Supply contracts governed by the laws of another jurisdiction would also be affected if the English non-supplier counterparty entered into a relevant insolvency process, although whether the restrictions imposed IA 1986, s 233B would be enforceable against an overseas supplier is likely to be a matter of the relevant local law. 

Limitations on the scope of IA 1986, s 233B

There are some important exclusions from the scope of IA 1986, s 233B. Certain entities (such as insurers and banks) as well as ‘financial contracts’ are excluded. As a result, lenders will still be able to exercise termination and any other rights triggered by counterparty insolvency. Importantly, lenders will retain their right to accelerate debts and take other action upon counterparty insolvency where permitted by the relevant loan documents. 

Potential changes in market practice to adapt to the effects of IA 1986, s 233B

In the light of these wide-ranging debtor-friendly provisions, creditors under relevant supply agreements may well change their approach in insolvency situations, for example by:

• requesting more frequent and more detailed financial disclosures from the supply recipient, to prevent them being caught off guard by the counterparty entering an insolvency process

• demanding more regular payment to reduce their exposure for post-insolvency supplies, and/or

• acting more quickly in exercising any rights to terminate for reasons short of insolvency, such as a non-payment, where a formal insolvency is feared

A powerful new cross-class cram down mechanism

The final key permanent CIGA 2020 development is the introduction of a new ‘restructuring plan’ into the CA 2006. While to date the moratorium has had little exposure in the courts, the same cannot be said of restructuring plans—and it is to be anticipated that their popularity will continue to grow. 
In many respects, the new restructuring plan process mimics the scheme of arrangement under Part 26A of the Companies Act 2006—and intentionally so, as CIGA 2020’s explanatory notes make clear that the commonality between the two should allow the courts to draw from the existing body of scheme of arrangement case law in applying the restructuring plan provisions.  This has proved to be the case in a number of restructuring plans to date. 

Approval of restructuring plans

To be eligible, a company must show that it has encountered or is likely to encounter financial difficulties that are affecting, or will or may affect, its ability to carry on business as a going concern, and there must be a compromise or arrangement proposed between the company and any of its creditors or members which is intended to eliminate, mitigate or prevent the financial difficulties. Ultimately, the court has a discretion whether to sanction the plan. 

As with a scheme of arrangement, the court will convene creditor and member class meetings to vote on the plan. The legislation states that every creditor or member whose rights are affected by the compromise or arrangement must be permitted to vote on the plan, but an application can be made to exclude any class of creditor or member where it can be shown that the class has no genuine economic interest in the company. 

For the plan to go ahead, it must be approved by 75% in value of each class present and voting; however, unlike schemes of arrangement, there is no requirement of approval by 50% in number of each class. 

Cross-class cram down

Significantly, and unlike schemes of arrangement, the much-talked-about ‘cross-class cram-down’ mechanism allows the court to sanction a plan even if not all classes have voted in its favour, thereby imposing the plan on one or more dissenting classes. This is a feature that is prevalent in other jurisdictions’ restructuring regimes and has been a gap in the UK’s legislation for some time. Its introduction will therefore have been welcome news to many in the restructuring and insolvency profession.   

For the cram-down to apply: (i) the court must be satisfied that none of the creditors or members would be worse off under the plan than under the ‘relevant alternative’ and (ii) the plan must be approved by at least one class of creditors or members which would receive a payment or have a ‘genuine economic interest in the company’ in the event of the ‘relevant alternative’. 

The relative alternative is whatever the court considers would be most likely to occur if the plan were not sanctioned. Beyond that, however, the key concepts of the ‘relevant alternative’ and ‘genuine economic interest’ are open to interpretation and will be—indeed, already have been—the subject of much debate in the courts. 

Restructuring plans have been used on a number of occasions since the legislation came into effect in June 2020, with the first use of the new cram-down mechanism coming at the start of 2021 with the High Court’s sanction of DeepOcean Group Holding BV’s restructuring plan ([2021] EWHC 138(Ch)). 
In June 2021, we saw a refusal to sanction a restructuring plan in the case of Hurricane Energy plc [2021] EWHC 1759 (Ch).

In Hurricane Energy, in brief summary, the plan proposal would have involved the company’s bondholders taking 95% of the equity in the company. During the convening hearing, Mr Justice Zacaroli found that the shareholders were ‘affected’ by the proposed restructuring plan, as their shareholding was proposed to be diluted from 100% down to 5%. In those circumstances, they were entitled to vote on the plan and should be included as a voting class under the plan. The shareholders rejected the plan at their class meeting. The company then sought to convince the court to exercise the cram-down mechanism such as to permit the plan to take effect despite its rejection by the members. However, the court rejected the company’s evidence that the ‘relevant alternative’ in the event the plan was not sanctioned was that the company would continue trading until May 2022, at which point it would be unable to repay its bonds and would enter into an insolvent liquidation. Instead, the court found that there was a realistic prospect of the company continuing to trade beyond May 2022 and being able to repay the bonds; and this meant that the court was not satisfied that the shareholders would be no worse off under the plan than the relevant alternative. 

This case is therefore a useful illustration that the court’s sanction is not a mere rubber stamp: the court will play an active role in the sanction process, and will scrutinise the evidence in support of the restructuring plan very closely. 

Temporary restrictions on winding-up petitions

As a response to the pressures faced by businesses as a consequence of the pandemic, the Coronavirus Act 2020 (CA 2020) introduced a moratorium on landlords forfeiting commercial leases for non-payment of rent (this came into force on 26 March 2020 and was recently extended, for a fifth time, until 25 March 2022).  Recent announcements indicate that the Government intends to put in place legislation which provides for rent arrears which have accrued during the period when a business was closed during the pandemic to be ring-fenced. Commercial tenants are expected to pay arrears if they are able to.  However, where a tenant is unable to pay and negotiations between the landlord and tenant are unsuccessful in resolving the position, the parties will have to go through a binding arbitration process.  More detail on the proposals is eagerly awaited.

The Government was (and remains) concerned that in the absence of a right to forfeit the lease for non-payment, landlords would instead turn to statutory demands and winding-up petitions to put pressure on their commercial tenants, as a way of sidestepping the forfeiture moratorium provisions. As a result, in April 2020, the government announced further protection in the form of temporary restrictions on the use of statutory demands and winding-up petitions.   It might have been expected, following that announcement, that these measures would be limited to actions by landlords against commercial tenants; however, when enacted through CIGA 2020, they were in fact much broader in scope, applying to all creditor petitions and not just those issued by landlords in relation to debts owing under commercial leases.  The current restrictions (the current restrictions) will come to an end on 30 September 2021 and will be replaced by new temporary restrictions (the new restrictions).   

Effect of the current restrictions 

The protection granted by CIGA 2020 is contained in Schedule 10 of CIGA 2020.  The protection is retroactive, taking effect from 27 April 2020. Its impact is twofold:

• First, no winding-up petition can be presented on or after 27 April 2020 based on a statutory demand served between 1 March 2020 and 30 September 2021—regardless of whether the failure to pay the demand is linked to coronavirus. 

• Secondly, it suspends a creditor’s ability to present winding-up petitions on or after 27 April 2020 on the basis of the debtor’s inability to pay its debts unless the creditor has reasonable grounds to believe that: 

  • coronavirus has not had a financial effect on the company, or 

  • if it has, the circumstances forming the basis for the winding-up petition would have occurred even if coronavirus had not had such a financial effect (collectively, the Coronavirus Test). 

The Coronavirus Test

Since its introduction in CIGA 2020, the interpretation of the Coronavirus Test has been the subject of some judicial attention. One such example was the case of Re PGH Investments Limited [2021] EWHC 533 (Ch). 

In that case, the court noted that the evidential burden is on the company to establish a prima facie case that coronavirus had a ‘financial effect’ on it before the presentation of the petition—ie that the company’s financial position worsened in consequence of, or for reasons relating to, coronavirus. That is a low threshold. If met, the burden will shift to the petitioner to show that even if the financial effect of coronavirus is ignored, the company would still be unable to pay its debts as they fall due.  

The court provided some useful, albeit obiter, guidance on the meaning of ‘financial effect’: on a proper construction, this term should be interpreted widely and could extend to indirect financial effects. The company’s position was that, whilst it had suffered no direct financial effect, it had suffered an indirect financial effect on the basis that coronavirus had resulted in a third party being unable to fulfil his obligations under a Share Purchase and Loan Assignment Agreement, triggering liability on the company’s part as a guarantor under that agreement. They argued that the coronavirus caused the company to incur a liability which it would not otherwise have incurred. The court found that, in principle, this could be a ‘financial effect’ within the meaning of the legislation, although it was not made out on the company’s evidence. 

Winding-up petitions as a pressure tactic: the new Insolvency Practice Direction 

In spite of the restrictions on winding-up petitions, creditors originally retained the ability to present a winding-up petition to the court even if, for reasons described above, it was likely to be dismissed. The publicity associated with such steps could itself prejudice the debtor company.  To combat this, a new Insolvency Practice Direction (IPD) was introduced, providing that that the existence of a winding-up petition will remain private (ie will not appear on any public search of the register, or be advertised) until the court has considered the Coronavirus Test and unless, following a pre-trial review and preliminary hearing, the court makes an order permitting the petition to proceed. This is a further welcome assistance for struggling businesses.

The new restrictions

To ensure landlords continue to be unable to issue a winding up petition in relation to certain accrued commercial rent arrears whilst at the same time tapering the restrictions on other creditors, the Corporate Insolvency and Governance Act 2020 (Coronavirus) (Amendment of Schedule 10) Regulations 2021 will come into effect on 29 September 2021.  The Regulations replace Schedule 10 CIGA 2020 and provide that during the “relevant period”, being 1 October 2021 to 31 March 2022, a creditor will be unable to present a winding up petition unless: 

• the debt is liquidated, due for payment, and is not an “excluded debt”.  “Excluded debts” are defined as debts in respect of rent or any sum or other payment that a tenant is liable to pay under a relevant business tenancy and which is unpaid by reason of a financial effect of coronavirus.  The definition of when coronavirus has a financial effect on a company was contained in the original Schedule 10 to CIGA 2020 and has not been repeated in new Schedule 10.   The Coronavirus Test is also not replicated in new Schedule 10 and there is no longer a requirement that the petition contain a statement from the creditor that it has reasonable grounds to believe that the pandemic has not had a financial effect on the debtor; 

• written notice containing certain prescribed information has to be delivered to the company at its registered office (or if that isn’t practicable, to its last principal place of business or to a director, company secretary or manager).  The notice has to include a statement that the creditor is seeking the company’s proposals for payment of the debt and if no proposal is made to the creditor’s satisfaction within the period of 21 days beginning with the date on which the notice is delivered to the company, the creditor intends to present a winding up petition;

• no satisfactory proposal has been received within the 21 day period; and

• the debt owed to the petitioning creditor (or creditors if more than one) is at least £10,000.

The creditor can apply to court to have conditions B and C disapplied in respect of a specified debt, or for the period of 21 days to be shortened to such period as the court may direct.

The petition has to contain a statement that the requirements of paragraph 1 of Schedule 10 have been met and that either no payment proposals have been made, or the proposals are not to the creditor’s satisfaction with an explanation of why.  

It is clear that the more restrictive regime that will apply to landlords is intended to work with the continued forfeiture moratorium.  However, there does appear to be a slight disconnect as the forfeiture moratorium is due to expire on 25 March 2022 and the winding up petition restrictions on 31 March 2022.  It is also not yet known whether a revised Insolvency Practice Direction will be issued on the expiry of the current one on 30 September 2021.

Effect of the pandemic on court proceedings 

The effect the pandemic has had a significant impact on the workings of the justice system in the Business and Property Courts in London. 

The onset of the pandemic forced the courts to undergo rapid procedural changes almost overnight, adapting to a ‘new normal’ of remote working and virtual hearings. These major changes have been implemented remarkably smoothly across the Business and Property Courts.  

In the insolvency context specifically, relevant changes to court process are implemented through the Temporary Insolvency Practice Direction (TIPD). The first TIPD came into force on 6 April 2020, and has subsequently been revised and extended as the pandemic has continued. The latest version was introduced on 30 June 2021 and will remain in force until 30 September 2021. Of relevance in the present context, it confirms that the hearing of winding-up and bankruptcy petitions will take place remotely, with other types of hearing taking place either remotely, in hybrid form, or in-person, at the court’s discretion (but taking into account the parties’ proposals). 

Alongside its practical effects on the court process, the pandemic is also expected to generate an increased workload in the courts as disputes are sparked by coronavirus-related issues. If previous experience of the 2008-2009 financial crisis is anything to go by, any increase may well be felt in the Insolvency & Companies Court in particular— although it could still take some time for these disputes to come to a head, as state support currently remains in place in various forms, interest rates remain low, and finance remains available for many businesses.

Even when the world begins to emerge from the pandemic and start the return to normal business, we can expect that the courts will not simply revert back to pre-pandemic ways of working. Some of the practices which have been developed out of necessity in response to the pandemic have found favour among the judiciary, legal teams, and parties alike, and may well be here to stay. Most notably, it seems likely that we will see increased use of virtual (or at least, hybrid) hearings for certain types of court business. 

Strategic considerations in insolvency-related disputes 

In the following sections, we address a number of wider strategic considerations arising in the context of disputes involving financially distressed or insolvent parties.

What analysis should be done by a would-be claimant before commencing a civil claim against a party in financial difficulty? What are the risks and how can they be mitigated?  

Success in Court proceedings can be measured in a number of ways. If you are seeking declarations against a defendant, a judgment in your favour and the making of the relevant declarations may be sufficient.  However, to the extent that as a claimant you are seeking damages or some other money remedy, a judgment in your favour is only the beginning.  If the defendant will not or cannot pay, and has no assets against which to enforce, there is a real risk of a pyrrhic victory in which you may not even recover your costs, let alone any damages you have been awarded. 

The practical future enforceability of any judgment is therefore a critical consideration and undertaking such financial due diligence on your counterparty as you can in advance is a valuable step.

What is the impact of party insolvency before or during civil proceedings? What steps should a claimant take in such circumstances, including in the context of enforcement?  

If a defendant becomes insolvent at any time before you have received payment or enforced your judgment (which is likely to be some time after you actually obtain judgment), as a claimant/judgment creditor you are likely to be an unsecured creditor. The unsatisfied judgment will  prima facie rank alongside all the defendant's other unsecured creditors in its insolvency and share pari passu in any assets of the insolvent estate that are available to the unsecured creditors. The reality of this in many insolvencies is that you will end up recovering only a very small fraction of the judgment sum.

A highly material exception to the position described above arises if you have a proprietary claim, or some other form of security which would mean that the assets you claim fall outside the insolvency estate entirely, or that your claim ranks ahead of ordinary unsecured creditors in the order of priority by which estate assets are distributed. 

In many cases, a creditor will not have any element of ‘choice’ as regards whether his or her claim against the distressed company is unsecured or proprietary, as the nature of the claim will be clearly one or the other. However, that is not always the case: for example, in some situations a supplier creditor who has delivered goods to a company which becomes insolvent will have both a claim for the unpaid price of the goods, and a proprietary ‘retention of title’ claim over the goods themselves until they are paid for (assuming the relevant contractual terms so provide, and other relevant conditions are met). In such a scenario, a valid retention of title right to recover the goods will often have much more practical value than the financial claim for the unpaid price of the goods (subject to the question of whether retention of title is affected by new IA 1986, s 233B and its ‘or any other thing’ wording).

Another issue that accompanies counterparty insolvency (whether before or during proceedings) is that upon entering administration or compulsory liquidation, a statutory moratorium is automatically imposed which prevents proceedings being commenced or continued except with the consent of the insolvency office-holder or the permission of the court. In high level terms, when assessing whether or not to grant permission, the court has a discretion and will weigh up the likely prejudice to the individual creditor if proceedings are not allowed to commence or continue against the likely prejudice to the remaining body of creditors if the proceedings are allowed to go ahead. The broad rationale for this rule is that once a company enters insolvency, prima facie the claims against it should be addressed by the office-holder through the insolvency process rather than through potentially costly and distracting litigation. Rather than each creditor going to court to assert their claims, such claims should be submitted to and adjudicated by the insolvency office-holder by way of a proof of debt in a more straightforward and efficient process. However, there will be cases where issuing proceedings may be necessary, for example if limitation periods are relevant.

If as a claimant you do not obtain consent, or the court's permission, to lift the moratorium and continue your claim, you would instead ordinarily need to submit a proof of debt in the insolvency setting out the details and quantum of your claim, which the office-holder will adjudicate upon.  If the office-holder rejects your claim in whole or in part, you can challenge that adjudication by way of an application to the court which is supervising the insolvency.

What issues should be considered concerning the availability of interim relief against a party in financial difficulty, including as a means of protecting yourself against costs risk? For example, should applications for security for costs or a freezing order be considered? 

In a situation where you are litigating against a party in financial distress but which is not in a formal insolvency process (such as administration or liquidation), you will undoubtedly want to consider what options you may have to seek interim relief from the courts to bolster your position and mitigate against the risk of the counterparty going into an insolvency process.  

One option which is sometimes considered is an application for security for your costs incurred in connection with the claim.  Such an application, if successful, will require the counterparty to pay money into court (or provide equivalent security, for example by way of a bank guarantee) so as to ensure that your legal costs will be recoverable if you are successful at trial.  

However, there are limitations to the availability of security for costs. Most importantly, it is generally only available if you are the defendant to a claim seeking security from a claimant. Accordingly, it is most relevant where you are being sued by a company which is in financial distress, but it is unlikely to assist in a straightforward case where you are pursuing a claim against the company in distress.  

Again, an exception to the above position can arise where the defendant in financial difficulty makes a counterclaim within the litigation proceedings, such that the claimant is also the ‘defendant’ to that aspect of the overall claim. Even in such a scenario, however, the claimant can typically only obtain security for that element of costs relating to the aspect of the claim in respect of which it is the defendant, not the full costs of the litigation.

It is also worth noting that a financially distressed claimant may be able to resist giving security for costs in certain limited circumstances if it can show that the requirement to give security would unfairly stifle its claim and it cannot raise the funds to be able to provide the security from other sources.  In considering such an argument, the court will weigh the potential prejudice to the claimant in its claim being stifled against the potential prejudice to the defendant in being forced to defend the claim without any security for its costs.  

Another option that parties litigating against a financially distressed counterparty may consider is a freezing order. In high level summary, a freezing order has the effect of freezing assets of a defendant in order to ‘hold the ring’ pending trial and/or enforcement. It is also usually accompanied by an order requiring the defendant to provide prompt disclosure of all of their assets above a certain value.  It can be obtained at any point before or during proceedings, including post-judgment.  However, it is a very draconian remedy, granted at the court's discretion, and an applicant will need to be able to demonstrate a real risk that the counterparty will dissipate its assets if they are not frozen – and to show this, it is unlikely to be sufficient that the counterparty is in financial difficulties without more.  In practice, a freezing order is not likely to be realistically available in the majority of cases.

As applicant, you would also need to provide a cross-undertaking in damages, in case the injunction turns out to have been wrongly granted, and this might need to be fortified by a payment into court of a material sum at the outset.  It is also important to note that a freezing order itself does not amount to security for your claim or give you priority in any insolvency: generally speaking, if they enter formal insolvency proceedings pre-enforcement, you would remain an unsecured creditor ranking equally among all unsecured creditors (unless the underlying nature of your claim was itself a proprietary claim).  

What are the alternatives to commencing civil proceedings against a party in financial difficulty?

Given the need to obtain a judgment and successfully enforce your claim before your counterparty tips into a formal insolvency process, time will often be of the essence when considering litigation against a counterparty in financial difficulty.  As such, any steps that you can take to accelerate the process are likely to assist, including a negotiated solution that avoids the need for a full court process. Considering early mediation, or other forms of alternative dispute resolution, to try to reach a prompt commercial solution can pay real dividends. 

In that context it is also relevant to be conscious of the risk that payments you receive from a party that subsequently falls into an insolvency process may be the subject of attempts by the office-holder to claw them back, for example on the basis that the payments were a voidable preference for the purposes of IA 1986, s 239. However, although it is prudent to be aware of this risk, in practice the risk of clawback should be minimal if the debt that has been satisfied was a bona fide debt and you were an arms' length creditor actively trying to recover what was owed, such that the debtor had no desire to prefer you over other creditors.

Authored by John Tillman, Oliver Humphrey and Danny Knowles.