Covid-19 and Insolvency: The Case for ‘Light-touch’ Administration

Different countries have adopted various strategies to prevent or delay initiation of insolvency proceedings and protect businesses in the wake of the Covid-19 Crisis. This has previously been discussed here on this blog. To summarize briefly, efforts are being made to provide direct financial aid (by way of loans and grants) and/or steps are being taken by way of emergency legislation to prevent ‘unnecessary’ insolvency proceedings. The overall aim of these strategies is to provide businesses with protection, albeit temporary, from creditor action. The protection is based on the premise that in a post-lockdown period, businesses will be able to become fully operational and profitable again, and will then be able to absorb/pay debts accrued as a result of the lockdown. Although these strategies are commendable, companies should consider being proactive as wholly depending on financial aid and delay strategies runs the risk of being overly optimistic for two reasons. First, the loans that are being offered by way of federal/state assistance will need to be to be repaid at some point. If the loans are not converted to grants or if the companies are unable to absorb and repay these loans, there will be a need for a macro-level restructuring. Second, the Covid-19 Crisis has caused a very real economic slowdown and it is not premature to believe that a post-Covid-19 world is an economically uncertain world, with implications for the viability of pre-lockdown business.

The above steps relating to aid and delaying creditor action are only buying companies time to delay creditor action. Therefore, the question that remains then is: what should corporate debtors, who have a stable and viable business and anticipate returning to profitability when the lockdown ends, do at this time to protect their business?

Exploring informal insolvency processes

Regardless of the nature and type of federal/state financial assistance (in the form of loans or grants) offered to corporate debtors in their jurisdiction, companies going through this slowdown should strongly consider exploring alternative insolvency proceedings that are primarily aimed at restructuring and protecting their business from creditor action.

One such option that businesses might benefit from is the UK Government’s impending legislation that introduces a moratorium on creditor winding-up petitions and enables businesses to create a ‘vehicle’ to implement a restructuring plan. Although the exact details of the legislation are not yet clear, the moratorium will temporarily suspend creditor winding up petitions and particularly bar creditors from introducing such petitions where the debtor’s inability to pay is due to Covid-19. This is a welcome measure that potentially protects businesses from the threat of creditor action. With regards to the restructuring plan, the Government’s statement does not go beyond stating that the restructuring plans in the new legislation are likely to be in line with the 2018 proposals.

However, in the absence of this new legislation, as of now, businesses should consider exploring other options that allow them to operate and at the same time protect them from creditor action. One such option is the ‘Light-touch’ Administration or ‘LTA’. Entry into an LTA, with a view to keep the business going, is likely to offer an immediate and a comprehensive solution to the problem of business that may be facing the risk of creditor action and/or are looking to restructure and renegotiate debt.

To put it simply, LTAs provide similar protection akin to the proposed Government moratorium and also provide a platform to implement a rescue strategy and negotiate with adverse creditors for all the debt that is being accumulated. The LTA process (recently made popular by the Debenhams administration) is fundamentally a tweaked-administration. The LTA is modelled on a Debtor-In-Possession (DIP) approach mirroring the US Chapter 11 Bankruptcy Code principles.

The ‘Light-touch’ stems from paragraph 64(1) of Schedule B1 of the Insolvency Act 1986 whereby the Administrators consent and devolve management powers back to officers of a company.

LTA allows company directors to file for administration but retain day-to-day control. The benefits are clear: the company gets all the usual protections offered by an administration such as protection from all creditor action (lenders, suppliers, HMRC) but the power to run the business is not handed over to Insolvency Practitioners. The idea is that once the lockdown is lifted the Administrators will take whatever additional steps are necessary to rescue the business (in line with the basic principles and objectives of the Insolvency Act 1986) and hand over full control to the directors of the company.

The debate around the use of LTA centres on two points. Traditionally, Administration was predicated on the assumption that where a company becomes insolvent, this is usually due to a failure of management and the last people who should be left in control are those who were responsible for the company’s plight in the first place. LTAs, however, put day-to-day control in the management’s control. The concern here is obvious. However, it is also worth mentioning that the main financial issues most businesses face right now are not due to management failure. Commercial and independent judgment is required to establish whether an LTA is appropriate in the circumstances or whether a more standard Administration process is more appropriate.

Second, with day-to-day control passing to directors, the Insolvency Practitioners face an increased burden that comes with discharging the statutory duties of an Administrator and also face significant potential risks by giving control to directors. An administrator could become personally liable for things that go wrong during the LTA particularly in relation to administration expenses or trading losses. This may also be concerns relating to more practical issues of funding, day-to-day financial security and GDPR compliance. There is also the issue, in some cases, whether the motivation of directors who wish to opt for an LTA is well founded. This is primarily an extension of the first point and an issue of oversight, monitoring and comfort on the part of the Insolvency Practitioner. By not having oversight of the management’s conduct, Insolvency Practitioners expose themselves to various risks for actions taken by the management in name of the company during the LTA. There are also concerns how creditors will react to such an arrangement. However, as with most insolvency proceedings, negotiation and dialogue are key.

To alleviate these concerns, the draft Consent Protocol (drafted by specialist barristers and endorsed by the Insolvency Lawyers Association), which is being used as a blue print to execute LTAs, provides for a range of conditions and restrictions that would potentially allow Insolvency Practitioners to keep management in check. Financial limits can also be put in place to limit the exposure of Administrators. These conditions and restrictions along with the power of Administrators to review transactions entered into by directors in the time-period before the commencement of the administration will allow Administrators to scrutinize the company activities in depth. Further, personal liability of an Administrator for losses that were suffered during the LTA would turn on (as it does in any other administration) whether the Administrator’s decision to enter into the LTA could be called into question. In Re Edennote [1996] 2 BCLC 389, it was confirmed that the Court would only interfere with the acts of a liquidator (reasoning here applies to administrators) if he has done something so utterly unreasonable and absurd that no reasonable man would have done it. Lastly, it is also important to not look at LTAs in isolation. As with most Administrations, Insolvency Practitioners would have the same powers and duties that they would have in the normal course such as the right to be consulted in relation to expense claims and observing their usual duties of due diligence. The ultimate aim of an LTA is essentially to protect potentially viable businesses.

It remains to be seen what the future of the LTA process will be once the new legislation is introduced. It can be argued that even if creditors can no longer threaten winding-up (as a result of the moratorium), there is still a need to restructure and if you have the management still in the ‘driving seat’, the process might be easier as they after all are the people who know their business best. It will also be a matter of interest to see the scope and effectiveness of the new moratorium and restructuring processes relative to the LTA/Administration exercise. Although there are additional concerns relating to the risk factors identified above, this is an evolving area of law where a practical balance needs to be struck between the potential risks associated with the process and the overall efficacy of undertaking an exercise such as the LTA that has the potential to save many businesses at a time of unprecedented financial distress. Companies that operate in jurisdictions where such an approach is not available could consider negotiating waivers or entering into contractual arrangements with creditors to protect their businesses.

Kumar Kartikeya Sharma is a dual-qualified barrister at the Bar of England & Wales and India.