As part of the changes to assist businesses ride out the COVID-19 storm, parliament has proposed a business debt hibernation scheme to supplement the existing insolvency mechanisms under the Companies Act 1993.

Business Debt Hibernation

The measure was intended for “businesses affected by COVID-19 to place existing debts into hibernation until [the businesses] are able to start trading normally again”.

Who can invoke the Business Debt Hibernation Scheme?

The Business Debt Hibernation Scheme (BDH) will not be available to sole traders, insurance companies, banks and non-bank deposit takers but will otherwise be available to all other companies and a range of other entities (trusts and partnerships). It is hoped that the BDH will:

• Increase dialogue between directors and creditors so that a simple proposal can be put in place to stay debts (i.e. put them into hibernation).
• Enable directors to retain control of their companies rather than having to pass them onto an insolvency practitioner;
• Give certainty to creditors about the retention of any payment they receive from a BDH business, in order to encourage continued trading with said business; and
• Be simple and flexible.

Features of proposed Debt Hibernation Scheme

The key features of BDH include:

• Minimum thresholds before BDH can be accessed by directors. It is currently unclear what the criteria will be. However, it is anticipated that companies will need to establish that the business would pass the solvency test under the Act, but for COVID-19, and that it is in the best interests of the company for a BDH to be put in place.
• If an entity meets the threshold, a minimum of 50% of creditors (by majority of number and value of debt) will need to agree to the BDH before it can be put in place.
• Once a BDH proposal is notified to creditors, a one month moratorium will immediately apply while creditors get the opportunity to cast their votes.

If a BDH is agreed to by creditors, it is binding on all creditors other than employees for a period of six months. The company can then continue to trade during that period, subject to any restrictions agreed with the creditors as a condition of the BDH.

If an agreement is not reached, creditors and the company can continue to take steps in the ordinary course, such as receivership or administration.

To further protect creditors, it has been proposed that mechanisms be put in place to protect third party creditors continuing to trade with a business during this period so they are protected from ‘claw back’ actions by a liquidator. Related parties cannot rely on the proposed exemption under the Act.

Anthony Harper comment

It should not be forgotten that the Act already has a number of mechanisms in place to allow companies to put proposals to their creditors. Administrations and compromises already exist – the amendments will supplement but not vary these established relief measures.

On its face, the change will greatly assist businesses while they work through cash-flow issues arising as a result of the Level 4 alert. However, there are a number of areas which will need to be thought through carefully.

In the first instance, parliament will need to consider whether the BDH applies to secured creditors. We expect that standard secured creditors (e.g. GSA holders such as the bank) will be brought into the equation, much in the same way they are included in a voluntary administration. Equally, it would be reasonable for creditors with specialised security (such as those holding specific security over equipment) to also be included.

It is unclear how the BDH will affect guarantors, though it is anticipated that there will be a moratorium on enforcing guaranteed debts against related party guarantors (e.g. directors and their relatives) as occurs in administration once the appointment of an administrator has been notified to creditors.

Robust threshold criteria should be set before a BDH can be invoked. Although it is understandably hoped that the BDH will be simple and flexible so that directors do not need to seek advice, the reality is, professional advice will be required if directors need to undertake a solvency test. A modified form of the test may be desirable. For example, a test which simply assesses liquidity in the six month period leading up to the Level 4 alert.

Clear guidelines regarding what constitutes effective notice of the BDH are desirable, particularly in light of the uncertainty around when the lock-down will be lifted. Experience tells us that giving notice of the proposal to the right people is a vexed issue. This needs to be done right and this is an area where professionals are most likely to end up being involved. If directors are serious about a BDH, ensuring proper notice is given so that the views of creditors can be properly canvassed is key.

As we noted previously, the devil is in the detail. The temporary measures have great potential to assist businesses with trading through, but also leave creditors exposed to greater harm if the right controls are not implemented to ensure that the BDH is not abused. We will know more once further details are released.