Month: January 2021

The main advantage of a formal arrangement using statutory procedures is that if the requisite majorities of creditors vote in favour of it, it is legally binding on all creditors, even if they voted against it or did not vote on it at all.

Three possible types of formal arrangement can be made:

• a Scheme of Arrangement under ss.895 – 901 CA 2006;
• a Company Voluntary Arrangement under ss.1-7 IA 1986; or
• a Restructuring Plan under CIGA 2020 the provisions of which are contained in part 26A CA 2006.

Scheme of Arrangement under ss.895 – 901 CA 2006

A scheme of arrangement is a complex formal arrangement or compromise made between the company and its creditors (or one or more classes of creditors). The compromise must be agreed by three-quarters in value and a majority in number of each relevant class of creditors at a meeting and then sanctioned (i.e. approved) by the court. Once the scheme has court sanction, it will bind all creditors including any dissenting or unknown creditors. However, because of the cost and the requirement of the court’s involvement, schemes of arrangement have tended to be used to restructure debt obligations of companies with significant secured liabilities or complex funding arrangements with tiers of secured and unsecured debt and, more recently, by foreign companies which have borrowed money from banks or other creditors under English law loan agreements.

There has been a recent trend where companies (UK and foreign) have been using schemes to extend maturity dates for the repayment of loans where the majority of lenders needed to agree this under the terms of the loan agreement cannot be obtained. It should be noted that if a company wishes to compromise secured liabilities and it does not have 100% agreement among the secured creditors as to how to achieve this, the only way a company can seek to compromise those liabilities is by way of a scheme or, as discussed below, by a restructuring plan. A CVA cannot be used.

A company may need to obtain a pre-insolvency moratorium or go into administration before proposing a scheme of arrangement in order to receive the benefit of a moratorium to prevent creditors from taking hostile action against the company or its assets during the period it takes to implement the scheme procedure.

Note: schemes of arrangement may also be used by a solvent company or a group of companies to effect a reorganisation or restructuring.

Company Voluntary Arrangement – ss.1-7 IA 1986

A CVA is usually less costly than a scheme of arrangement mainly because it does not require court sanction. Often, the purpose of a CVA is to seek to put in place a timetable for the repayment (usually only in part) of liabilities owed to (usually) unsecured creditors which will enable the company to survive; alternatively, where rescue is not feasible, CVAs can be used to achieve a better asset realisation and distribution to creditors than would be the case in a winding up. The CVA is implemented and supervised by a “supervisor” (who until approval of the CVA by creditors is known as the “nominee”). The nominee/supervisor must be a licensed insolvency practitioner (‘IP’).

Setting up a CVA

In order to implement a CVA, the directors of the company, usually advised by an IP, formulate a written proposal for the repayment or restructuring of the company’s debts. The proposal will include the nomination of the IP (called a nominee) to act as the supervisor of the arrangement. Once the proposal has been finalised (perhaps after having consulted with major creditors in advance and making sure they are on board with the proposal), the nominee will seek creditors’ approval for the CVA using one of a number of permitted decisionmaking procedures provided for under the IR 2016 (likely to be a virtual, or possibly a physical, meeting). Once the creditors’ decision has been made, the nominee must call a separate meeting of the company’s shareholders (to be held within 5 days of the creditors’ decision).

Two creditor majorities are required if the CVA proposal is to be approved. The first is that at least three-quarters in value of those creditors who respond to the nominee’s chosen decision procedure vote in favour of it. There is no requirement for a majority in number of creditors to vote in favour (in contrast to a scheme). The second majority which is needed is that the proposal must be approved by a simple majority in value of unconnected creditors (e.g. the claims of related companies must be ignored for this purpose). The members approve the CVA by passing an ordinary resolution (their voting rights to be determined by the company’s articles of association).

If the CVA proposal is approved by the majorities of creditors and members (or if the members vote against, by the creditors alone) referred to above, the CVA proposal binds (subject to what we say below about secured creditors and CVA challenges) all creditors i.e. those who voted for it, those who voted against it, those who did not vote at all and those creditors who did not receive notice of the decision-making procedure adopted to approve the CVA. All those creditors’ claims are then dealt with in accordance with the terms of the CVA.

A CVA cannot compromise the rights of secured creditors (including the right to enforce security) or the rights of preferential creditors without their unanimous consent. In practice, secured creditors rarely agree to be bound by a CVA and a company would have to seek a consensual agreement with them (which may be conditional on unsecured creditors voting in favour of a CVA on certain terms) or may have to propose a scheme of arrangement in order to compromise secured liabilities.

CVA challenges

A creditor can challenge a CVA within a 28 day period (commencing with the date of filing of the nominee’s report on the approval of the CVA on grounds of “unfair prejudice” (i.e. one creditor has been treated under the CVA unfairly compared to another creditor) or because of a “material irregularity” relating to the procedure which the company has followed in seeking the approval of the CVA (such as the way that creditors’ votes were calculated). Subject to that, a CVA becomes binding on all creditors at the end of the 28 day challenge period.

The Supervisor’s role

Where the directors propose a CVA, the directors remain in place during the CVA and will be able to exercise their usual powers except as the CVA proposal provides otherwise. The supervisor’s role will be to agree creditors’ claims, collect in the funds which the company is to use to pay dividends to the creditors on their agreed claims and generally ensure that the company complies with its obligations under the CVA. When a CVA has been completed, the supervisor will send a final report on the implementation of the proposal to all members and creditors who are bound by the CVA, then step down from his position and the company will carry on under the management of its directors in the normal way.

CVAs used in conjunction with other pre-insolvency and insolvency procedures

An administrator and liquidator can also propose a CVA. A company may need to obtain a pre-insolvency moratorium or go into administration before proposing a CVA in order to receive the benefit of a moratorium to prevent creditors from taking hostile action against the company or its assets during the period between the sending out of notice to the creditors of the CVA decision procedure and the holding of the procedure itself (e.g. a virtual meeting) which will be at least 14 days. The same IP will usually act as monitor under a pre-insolvency moratorium or as administrator, liquidator or supervisor of a CVA.

Small companies’ CVA and moratorium procedure

Directors of certain “small” companies have the option of applying to the court for a short moratorium (initially 28 days) in order to propose a CVA; see amended s.1A and Schedule A1. This moratorium provides the company with protection from hostile creditor action in the period up to the time when the creditors decide whether to approve the CVA proposal. ”Small companies” are defined in s. 382(3) CA 2006. Where the application is made, the company will have the benefit of an administration style moratorium. In practice, very few companies have used the “small companies” CVA and moratorium procedure.

Restructuring plan under CIGA 2020

CIGA 2020 has introduced a new restructuring plan that may well displace in many cases the use of CVAs and schemes of arrangement. The purpose of a plan is to compromise a company’s creditors and shareholders and restructure its liabilities in such a way that the company is made solvent and can continue as a going concern.

Restructuring plans can only be used by companies which have or are likely to encounter financial difficulty. Restructuring plans must comprise of a compromise or arrangement used to eliminate, prevent or mitigate the impact of financial difficulties that a company is facing.

The restructuring plan is a hybrid of schemes and CVAs. The procedure for implementing a restructuring plan is similar to a scheme. It is therefore a court driven process and the plan becomes binding on all creditors following the court sanctioning the plan. Like schemes, creditors and members must be divided into classes and each class which votes on the plan must be asked to approve it.

The votes needed by the class meetings for approval are more similar to those under a CVA i.e. the plan must be approved by at least 75% of each class voting; there is no majority in number requirement as there is for schemes.

The restructuring plan procedure has some novel features. Two are worthy of mention:

• The court can exclude creditors and shareholders from voting even if they are affected by the plan if they have no genuine economic interest in the company (e.g. they would not receive any payment from the company in any other realistic outcome for the company).
• The court can sanction a plan which brings about “cross-class cram down”.

The second point is best explained by way of an illustration. Suppose the company has senior and junior creditors. The senior creditors have the right to receive payment before the junior ones. The court can sanction a plan approved by the senior creditors even if rejected by the junior creditors provided the court is satisfied that (i) the junior creditors are no worse off under the plan they would be in the relevant alternative outcome for the company (this might be a liquidation, administration or following a sale of the company’s business as a going concern) and (ii) the plan has been approved by a class of creditor or shareholder which would receive a payment or have a genuine economic interest in the company in the relevant alternative outcome.

Consider another example of a cross-class cram down. The court could sanction a plan approved by the junior creditors but rejected by the senior creditors if (i) the junior creditors would receive a payment or have a genuine economic interest in the company in the relevant alternative outcome for the company, (ii) the senior creditors receive under the plan at least what they would have received in the relevant alternative outcome and (iii) the court considers the plan to be fair.

A restructuring plan can be thought of as better than a CVA because it can compromise the rights and claims of secured creditors and shareholders. A CVA cannot do this. The restructuring plan can also be thought of as better than a scheme because in general, a scheme is only binding on those classes of creditors or shareholders who vote in favour of it. This is not the case for restructuring plans because of its ‘cross class cram down’ feature. It can also force through changes in shareholdings which a scheme cannot do. Finally, schemes of arrangement can be used by solvent companies. Restructuring plans can only be used by companies facing actual or prospective financial difficulty.

A company may need to obtain a pre-insolvency moratorium or go into administration before proposing a restructuring plan in order to receive the benefit of a moratorium to prevent creditors from taking hostile action against the company or its assets during the period it takes to implement the scheme procedure. An administrator and liquidator have power to propose a restructuring plan but in most cases, it will be the directors who will do so (very possibly having first obtained a pre-insolvency moratorium).

The pre-insolvency moratorium has been introduced by CIGA 2020. Come late summer and the autumn 2020, it is unlikely to have been used very much but it can be expected that its use will become widespread through time. Pre-insolvency moratoriums will be used to achieve consensual restructurings, but can also be used by a company as a preliminary step to proposing a restructuring plan, a CVA or a scheme of arrangement.

Most UK companies will be eligible to obtain a pre-insolvency moratorium. It is easy to obtain; some documents have to be filed at court and the moratorium begins immediately. The most important documents that the company must file at court are firstly, a statement that the company is, or is likely to become, unable to pay its debts and secondly, a statement from a ‘monitor’ that it is his or her view that is likely that a moratorium would result in the rescue of the company as a going concern. A monitor must be a licenced insolvency practitioner (or ‘IP’) and will usually be an accountant. He or she will have a supervisory function during the moratorium as explained below. CIGA 2020 confers the status of ‘officer of the court’ on a monitor.

There is no court hearing to obtain a pre-insolvency moratorium and so the procedure is an out of court one. The commencement of the moratorium has to be notified at the Companies Registry and the company must do certain other things to publicise that it has obtained a moratorium. Interestingly, the company does not have to give prior notice to any qualifying floating charge holder before it obtains a pre-insolvency moratorium (in contract to the position when directors apply out of court for the appointment of an administrator).

The pre-insolvency moratorium lasts for an initial period of 20 business days but the directors can extend the period once by another 20 business days. The moratorium can be extended beyond the first 40 business days if more than 50% in value of each of the unsecured creditors and the secured creditors (in each case, only those whose claims against the company are subject to the statutory payment holiday described below) approve the extension or if the court orders an extension. The moratorium can last for a maximum period of one year but can last longer if the court consents. For any extension to take place, the directors must confirm that all ‘moratorium debts’ and all pre-moratorium debts not subject to the statutory payment holiday explained below have been paid when due and payable and the monitor must confirm that it is his or her view that the moratorium is likely to result in the rescue of the company as a going concern. The moratorium will continue automatically if the company proposes a a CVA and it will last until the outcome of the CVA proposal becomes known. The court when sanctioning a restructuring plan or a scheme of arrangement has the power to extend the moratorium for the duration of the plan or scheme.

What is a moratorium? The origin of the word comes from the Latin ‘mora’ which means delay. The key feature of the moratorium is that creditors’ rights are delayed or suspended while the moratorium exists and they cannot exercise those rights unless the court or the monitor otherwise allows. The actions restricted by the moratorium are substantially the same as with the administration moratorium which ae discussed later. These include:

• no creditor can enforce its security against the company’s assets
• there is stay of legal proceedings against the company and a bar on bringing new proceedings against it
• no winding up procedures can be commenced in respect of the company (unless commenced by the directors) and no shareholder resolution can be passed to wind up the company (unless approved by the directors)
• landlords cannot forfeit leases; and
• retention of title creditors and lessors cannot take possession of their assets.

In addition:

• no administration procedure can be commenced in respect of the company (other than by the directors); and
• no action can be taken to crystallise a floating charge (that is, turn it into a fixed charge).

The monitor’s role is limited to ensuring the circumstances exist whereby it remains the case that it is likely that the company can be rescued as a going concern and must approve all asset disposals outside the ordinary course of business or the grant of new security over the company’s assets. This means that during the moratorium, the directors continue to manage the company’s business and affairs. The pre-insolvency moratorium is therefore a rare example of ‘a debtor in possession’ procedure under UK law. As we shall see below, in the more formal insolvency procedures, the directors usually lose their powers in favour of the administrator, receiver or liquidator.

Creditors and shareholders can challenge the actions of directors during the moratorium on the ground that their interests have been unfairly prejudiced. The directors, creditors and shareholders can challenge the actions of the monitor on the same ground although the monitor cannot be required to pay compensation.

Another key feature of the pre-insolvency moratorium is that the company receives a statutory payment holiday in respect of ‘pre-moratorium debts’. This means the company does not have to pay the pre-moratorium debts while the moratorium subsists. A pre-moratorium debt is a debt that is already overdue for payment by the time the moratorium begins or one which was incurred under a contract entered into before the moratorium begins but falls due afterwards.

There is a carve-out from the definition of pre-moratorium debts for amounts due under a contract involving ‘financial services’ which includes loans, guarantees for loans and various capital market and financial transactions. These are examples of ‘pre-moratorium debts without a statutory payment holiday’. This means that a company remains liable to pay all amounts due to a bank which made a loan to it before it obtained a moratorium in accordance with the terms of the loan agreement and if the company does not do so, the bank can exercise all its contractual rights such as levying default interest, terminating the loan and accelerating its repayment. Interestingly, banks will not be able to exercise many important remedies to recover the loan if there is a default during the moratorium. For example, the bank will not be able to enforce its security over the company’s assets (and so cannot appoint an administrator or a receiver) or bring winding up proceedings against the company. This is because such actions are prohibited by the moratorium unless the court orders otherwise or the monitor otherwise consents. In practice, it is envisaged that companies will only obtain a pre-insolvency moratorium with the support and prior approval from their banks and even then, may only do so if it has entered into a standstill agreement with their banks under which the banks agree not to exercise their contractual and security rights for a specified period. This is because the banks’ contractual rights to terminate and demand repayment of facilities are not affected by the pre-insolvency moratorium and if banks did exercise their contractual rights to accelerate and make demand for repayment, the company would almost certainly not be able to pay what was then due. In these circumstances, the monitor is obliged to bring the moratorium to an end. Following termination of the moratorium, the banks could enforce whatever security they had.

There is no statutory payment holiday for ‘moratorium debts’ and the company must pay them in the usual way. Examples of moratorium debts are the monitor’s fee, debts owed for supplies of goods and services made to the company during the moratorium, rent due in respect of the moratorium period and all salaries owed to employees, regardless of when the salaries were due to be paid. What this means in practice is that companies must be ‘cash flow’ solvent and capable of paying their way during the moratorium period. Although suppliers and landlords owed moratorium debts cannot take action to recover their debts which are prohibited by the moratorium, CIGA gives them protection in two ways. The first is that if the company cannot pay a moratorium debt when due, the monitor is under an obligation to bring the moratorium to an end. Secondly, provided the company enters into a liquidation or administration within 12 weeks after the end of the moratorium, these debts are given a ‘super priority’ status in the statutory order of priority which we will look at later in this chapter. This means these debts must be paid out of floating charge realisations ahead of all other creditors (such as floating charge, preferential and prescribed part creditors). They will rank only behind fixed charge creditors.

These two protections are also available to creditors whose debts are premoratorium debts not subject to the statutory payment holiday (such as debts owed to banks under loan agreements) but the debts will not receive super priority status if they fell due during the moratorium as a result of acceleration or early termination of a loan agreement.

A pre-insolvency moratorium is intended to be an initial step to a company completing a recovery and there are various ways it can come to an end. These are:

• entering into a consensual restructuring agreement with those creditors needed to enable the company to continue as a going concern
• the court sanctions a restructuring plan or scheme of arrangement
• the company’s proposal for a CVA is approved by creditors
• the company takes steps to place itself into administration or liquidation
• the moratorium expires
• the court orders the moratorium to end; and
• the monitor brings it to an end e.g. because it is no longer likely that the company can be rescued as a going concern or if the company ceases to be able or it is unlikely that the company will be able to pay when due its moratorium debts or pre-moratorium debts for which there is no statutory payment holiday (such as bank loans).

It is open to a company to negotiate and agree deals with one or more of its creditors, that is, on the basis of a contractually binding agreement under which the debtor will have longer and/or less to pay and/or the payment terms are otherwise changed in a way which is beneficial to the debtor. These sorts of deals are not regulated by the IA 1986 or CIGA 2020 and do not involve the company entering into a ‘formal insolvency procedure’ (by which is meant an administration, a liquidation, a restructuring plan, a CVA or a scheme of arrangement). Where they can be done, they represent a relatively easy, quick and cheap way for companies to restructure their liabilities. However, the main difficulty with them will be in trying to reach agreement with all necessary creditors at the same time. Creditor A may be unwilling to compromise its debt claims against the company unless creditors B, C and D do so on acceptable terms at the same time and vice versa.

If agreement can be reached, it will often be documented by a restructuring agreement. This will have contractual force and if entered into in a workable timescale, the company will avoid a formal insolvency procedure and it will survive in its current form.

As a preliminary step to beginning negotiations with creditors, the company may have to enter into a ‘standstill agreement’ with relevant creditors (perhaps just the major ones) in which they agree on a binding basis not to exercise their usual rights and remedies for a specified period to enable the parties to have time to negotiate the terms of the restructuring agreement. The need for standstill agreements is likely to continue even though a company can obtain a pre-insolvency moratorium out of court under CIGA 2020 which prevents creditors from exercising certain remedies (such as enforcing security) during the existence of the moratorium. Although the aim of the moratorium is to give the company time to negotiate a restructuring deal with creditors with a view (if possible) of rescuing the company as a going concern, financial creditors are still able to exercise all their contractual rights during a pre-insolvency moratorium and as explained below, if they do so, this is likely to mean the moratorium will come to an early end.

In a restructuring agreement, the debtor will often seek a combination of debt write off, debt rescheduling and/or or grant of additional facilities. To obtain creditor agreement, the company may have to do one or more of the following: (i) grant new or additional security, (ii) replace directors or senior employees, (iii) sell failing businesses or subsidiaries or profitable ones in order to raise cash, (iv) reduce the workforce or the salary bill, (v) issue new shares to the creditors (this is known as a “debt for equity swap”) and/or (vi) procure that the directors or others grant guarantees for existing or new facilities.

To identify an insolvency situation

Directors must continually review the financial performance of their company. They need to be able to recognise when the company is in financial difficulty. Indicators of financial difficulty include the following:

• the company has many unpaid creditors who are putting the company under increasing pressure to pay its bills; and
• the company cannot use its overdraft facility for temporary relief as the facility is fully drawn and the bank is refusing to extend further credit.

It is the directors who need to decide what action to take on behalf of the company. In making that decision, the directors will need advice on their duties, responsibilities and liabilities under the IA 1986 and general law and their options under the IA 1986 and CIGA 2020 for resolving their companies’ financial difficulties and the exposure of creditors to losses.

Can the directors ignore financial difficulties and simply keep a company trading?

Doing nothing to address a company’s financial difficulties is not an option. If the company enters into an insolvent liquidation or administration, directors can be made personally liable to contribute to the company’s assets under the provisions of the IA 1986 dealing with wrongful or fraudulent trading. In addition, in an insolvency situation, a director’s duty to promote the success of the company under s.172 CA 2006 is subject to any enactment or rule of law requiring directors to consider or act in the interests of creditors of the company (see s.172(3) CA 2006). This refers to the preservation of the common law rule that once the company is facing the prospect of insolvency, the directors’ duty to promote the success of the company switches to protecting the interests of the creditors. A director’s breach of this duty can make him or her liable to pay damages to the company under s. 212 IA 1986 which deals with misfeasance.

The directors also risk disqualification under the Company Directors Disqualification Act 1986.

There is, therefore, an obligation on the directors to recognise when a company risks becoming insolvent and to take appropriate action.

Should the directors try to save the company or its business?

Faced with a company in financial difficulty, the directors have several options. The first decision of the board is whether to aim for the survival of the company (either with or without the aid of a formal insolvency procedure) or whether the company’s financial predicament is so great that at best, only the company’s business can be rescued (e.g. by the sale of the business and assets as a going concern to a buyer). If the latter option is the only viable one available, it is very likely the company will have to enter into a formal insolvency procedure to achieve it.

If the directors wish to try to aim to preserve the survival of the company, there are various turnaround strategies. These include restructuring the company’s debts perhaps by obtaining a pre-insolvency moratorium to achieve a consensual contractual arrangement with some or all creditors or through a company voluntary arrangement (‘CVA’), a restructuring plan or a scheme of arrangement (as discussed below). As part of this process, the company may also need to bring in new management and/or replace existing directors. The directors may appoint turnaround specialists (sometimes called company doctors) or specialist financial advisors, both of whom offer independent, informed advice. Turnaround is a growing specialism within business and the law and can be cost effective and successful if approached in the right way.

A turnaround specialist or financial advisor will act quickly to carry out an appraisal of the company’s situation and, if it is possible to rescue the company, establish an action plan.

If the directors, assisted by their advisors, conclude that it is not possible to turn around the fortunes of the company so as to preserve the company’s survival, then there are various insolvency procedures available to deal with the company’s predicament. This Chapter will examine the various procedures available to financially struggling companies.

Introductory matters

The terminology used in this post and the ones that follow it can be confusing. It is important that you get used to using the correct terminology as it will clarify your analysis of insolvency law. I will include a glossary later, for you to refer to as you read this post. I will italicise words that appear in the glossary the first time they are referred to in the body of these posts.

The aim of corporate insolvency law and the rescue culture

Corporate insolvency law relates to failing companies. The underlying aim of corporate insolvency law is to protect and balance the interests of competing creditors and to promote a culture where failing businesses are rescued and can recover. The idea is that creditors are likely to recover more money if businesses can be rescued or restructured than if they are closed down and the assets sold off.

Relevant Legislation

The main relevant statute was until very recently is the Insolvency Act 1986 (the ‘IA 1986’). Although of still of prime importance as a source of insolvency law, the IA 1986 Act must also now share prominence with the Corporate Insolvency and Governance Act 2020 (‘CIGA 2020’) which came into force on 26 June 2020. CIGA has introduced new insolvency procedures into the law of England and Wales and made consequential amendments to the IA 1986.

IA 1986 and CIGA are supplemented by the Insolvency (England and Wales) Rules 2016 (the ‘IR 2016’) which, in the main, deal with procedural matters. These Rules came into force on 6 April 2017 and replaced the Insolvency Rules 1986. The IR 2016 consolidate nearly 30 years’ worth of amendments made to the Insolvency Rules 1986, they restructure and update the language of the Insolvency Rules 1986 and give effect to certain policy changes and changes to the IA 1986.

Unless otherwise stated, section, schedule and rule numbers mentioned in this post refer to sections of and schedules to the IA 1986.

Note that the IA 1986 itself has been substantially amended over the years, in particular by the Insolvency Act 2000, the Enterprise Act 2002 (‘EA 2002’), the Companies Act 2006 (‘CA 2006’), the Deregulation Act 2015 and the Small Business Enterprise and Employment Act 2015 and as already mentioned, CIGA 2020 has introduced new insolvency procedures.

The most significant reforms to the law of insolvency since the IA 1986 was enacted were contained in the EA 2002 and CIGA 2020. Let us deal with each in turn.

Summary of EA reforms

The EA came into force on 15 September 2003 (the ‘Relevant Date’).

The aims of the corporate insolvency reforms contained in the EA 2002 were:

• to promote the rescue culture;
• to increase entrepreneurship by giving prominence to collective insolvency procedures over enforcement procedures; and
• to remove the stigma attached to personal insolvency (bankruptcy) as a result of running a failed business in order to encourage a more U.S. style approach to entrepreneurship.

The focus of the EA 2002 was on streamlining the administration procedure to encourage company rescue and to restrict the use of administrative receiverships by holders of qualifying floating charges.

Summary of the CIGA 2020

CIGA introduces two new insolvency procedures: the pre-insolvency moratorium and the new restructuring plan for companies. These are intended to make restructurings which avoid an administration or liquidation more likely and hence they promote the rescue culture beyond what the EA 2002 sought to achieve. The effect of the CIGA reforms is to continue the path forged by the EA 2002 of making UK insolvency procedures less creditor friendly and more debtor friendly and thereby achieve a greater balance of power between creditors and debtors.

CIGA has also introduced temporary changes to the IA 1986 to help mitigate the economic impact on businesses caused by the Coronavirus pandemic.

CIGA has also prohibited the enforceability of termination clauses in most types of contracts for the supply of goods and services which allow the counterparty to terminate the contract on the ground that the company has obtained a pre-insolvency moratorium or has entered into administration, liquidation or administrative receivership or its creditors have approved a CVA or the court has sanctioned a restructuring plan or a scheme of arrangement. There is also a prohibition on suppliers making it a condition of any future supply that pre-insolvency debts owed to them must be paid. The effect of these prohibitions is that suppliers must continue making supplies under the terms of the contract notwithstanding the company has entered into one of these procedures provided the company pays for supplies made after the commencement of the relevant procedure. The prohibitions (i) do not apply to loans and other types of financial contracts, (ii) do not prevent termination of a contract or a licence if the company commits a default after it enters into an insolvency procedure or (iii) if the supplier terminates the contract pursuant to a contractual clause that allows the contract to be terminated by the giving of a notice (e.g. a three months’ notice termination provision).

Some of the areas that I have covered in previous posts (or will cover in future posts) on business law will be relevant when you are advising a client acquiring or disposing of a business or company. These are as follows:

Formation of a private company

It is common for corporate transactions to involve the purchase of target through a ‘newco’. This is a newly incorporated company set up by the buyer to act as the purchasing vehicle. This is especially common in management buyouts and other private equity transactions.

Equity and debt finance

Issues of finance will usually arise for the acquiring client who will often need to raise finance in order to acquire target.

If the company acquiring or disposing of target is a listed company then the provisions of the Listing, Prospectus, Disclosure and Transparency Rules (LPDT Rules) will need to be considered. If the transaction meets certain criteria in accordance with the LPDT Rules the transaction may need prior shareholder approval.

Accounts

Whether it is during the due diligence process or to assist you in working out the consideration to be paid for target, accounts will play a key part in every transaction. It is important that transactional lawyers understand business
accounts in order to be able to advise fully.

Employment law

There are strict regulations in relation to the transfer of employees that apply on a business sale, such as in relation to TUPE.

Financial Assistance

It is quite often the case that financial assistance will be given during the course of a share sale. You will need to understand how to identify a transaction involving financial assistance and how to ensure that, where target is a
public company or has a subsidiary which is a public company, no illegal financial assistance is given in the course of financing the transaction. Since 1 October 2008 it is no longer unlawful for private companies to give financial assistance in relation to the acquisition of their own shares or shares in their private holding companies.

Lawyers

There are many areas of a business that are governed by different legislation. For example, the employees and their contracts of employment will be governed by employment law, the intellectual property rights owned by the business will be subject to intellectual property law and the real estate owned by the company will be subject to property law. As a corporate lawyer you are expected to have a grounding in these areas but you cannot possibly have a detailed knowledge of every area of law.

As a result of this it is common for transactional lawyers to have assistance from other lawyers in the firm specialising in different areas of law. This is known as corporate support.

Corporate support will be particularly useful when conducting due diligence and considering appropriate warranties and indemnities. Transactional lawyers are required to act as both a facilitator and also an organiser. You may be required by your client to report back to him on all of the areas that your colleagues are working on, unless there is a direct line of communication between your client and the specialist lawyers themselves. The most difficult task that a transactional lawyer often undertakes is keeping up with all of the issues across the different areas of the deal and ensuring that all of the relevant issues have been addressed in the documentation.

(Note: the target may have overseas operations, in which case overseas counsel will also need to be instructed. These lawyers may assist with matters such as undertaking due diligence on aspects of the target’s business which are governed by foreign law or regulation, drafting or reviewing warranties and indemnities concerning the overseas aspects, and arranging and overseeing any completion or post-completion requirements which need to take place in their jurisdictions, such as local registration of IP rights.)

Accountants

Transactional lawyers also need to work closely with the client’s accountants. As well as carrying out financial, accounting and tax due diligence, the accountants will probably dictate to a large extent the structure of the deal (which will often be tax driven) and this is why a good grounding in basic accounting and tax principles is crucial.

If the parties have agreed that the terms of the acquisition will include an earn out (a type of deferred consideration), or if the price is to be based on completion accounts, accountants will also advise the parties on the basis on which the earn out will be calculated or on which the completion accounts will be drawn up.

Business strategy

In order for you to provide the best possible legal advice to your client whether as buyer or seller and to enable you to negotiate the best possible deal it will be important for you to have some idea of your client’s business strategy. If your client is the seller, why is it selling? If it is the buyer how does it envisage that the acquired business will fit into its existing business?

You need to make sure that you are aware of your client’s objectives for buying and selling and this will involve you trying to establish a basic understanding of your client’s business and the market that your client’s business operates in.

There are many reasons why a client may choose to sell a company or business. These may include:

Commercial reasons where the business cannot keep up with the latest developments in the market in its current format. For example, a telecoms business that cannot afford to invest in new technology and cannot raise finance. In this situation the best option may be for the business to be purchased by a larger company in the same industry that will have money to invest in the technology;

Non-commercial reasons such as the illness or retirement of the individual owners. Non-commercial reasons can also include a lack of interest by business owners (for example where a business is inherited) or the inability of an owner of retirement age to find a successor; and/or

Financial reasons where the business needs to raise finance in order to avoid the failure of either part or all of its business.

Whatever the reason, as a transactional lawyer one of the most important parts of your job will be to understand your client’s business objectives and to ensure that the deal is structured in order to ensure that these objectives are met.

Completion

Where exchange and completion are simultaneous, the buyer and the seller and their representatives will meet in order to complete the transaction. This will usually involve signing all of the acquisition documentation and holding all of the relevant completion board meetings. It is also usual for a certain amount of last minute negotiation to take place at the completion meeting.
Where there is a split exchange and completion, the completion meeting will usually just be a formality (as described in paragraph 5.4 above) and there should not be any last minute negotiations.

Post completion

Following completion the buyer will spend most of its time dealing with the integration of its new business into its existing business (if it has one). The lawyers will need to deal with post completion issues such as statutory filings, updating statutory books, payment of stamp taxes etc. It is also customary for one of the lawyers to put together a ‘bible’ of copies of the executed completion documents. Every party then receives a copy of the bible and it is used by the parties to remind them of the terms of the transaction as and when necessary in the future.

Whether the transaction is to be structured as a share sale or an asset sale, similar documents will be required.

At the beginning of every transaction most lawyers prepare a checklist listing the documents that will be required in order to complete the transaction. On a sale by private treaty (a bilateral process) where there is only one buyer and one seller, the parties will agree between them who will be responsible for drafting each document. In practice the buyer’s lawyers often carry out most of the drafting but this can vary depending on the circumstances.

The principal documents on a sale by private treaty are as follows.

Confidentiality agreement

Before negotiations begin and certainly before the prospective buyer is given any sensitive information about the seller or target, the seller will ask the buyer to enter into a confidentiality agreement (also known as a non-disclosure agreement or ‘NDA’) pursuant to which, in consideration for providing the buyer with information regarding target and/or the seller, the buyer agrees to (and agrees to procure that its advisers will) keep such information secret. The obligations in the confidentiality agreement will usually continue indefinitely and will survive even if the transaction subsequently does not complete (although, where a private equity house is involved in a transaction, confidentiality agreements may be seen which are subject to a time limit, for example of two or three years. There are a number of other variations to the acquisition process and documents where private equity houses are involved).

The buyer will usually also ask for mutual confidentiality undertakings from the seller in so far as the seller obtains any confidential information relating to the buyer during the course of the negotiations.

Heads of agreement/Heads of terms

Heads of agreement are often used to set out the parties’ basic understanding of the key commercial terms and structure of the deal. They are merely an expression of the intention of the parties to act as a road map for the full form contract and, generally speaking, are not legally binding.

However, as heads of agreement can take a long time to negotiate (and only carry moral force), it is not uncommon for the parties to proceed straight to a full-form binding contract.

Where heads of agreement are used they often contain clauses relating to confidentiality (if a separate confidentiality agreement has not been entered into) and exclusivity/lock-out. If this is the case, it is crucial that these provisions (and any other provisions that the parties intend to be legally binding) are expressly stated to be legally binding.

Exclusivity relates to undertakings given by the seller pursuant to which it agrees not to solicit offers for target from any other source provided that completion takes place by a certain date. A buyer will usually insist on some form of exclusivity undertaking in order to ensure that it is not in a position where it will be in competition with another buyer and wasting legal/accountancy costs.

Due diligence

A buyer is always going to be subject to the maxim of caveat emptor – buyer beware. This means that it is the buyer’s responsibility to ensure that it obtains detailed information relating to the company or business that it is going to purchase prior to completion.

The buyer obtains the information that it needs by going through a process of due diligence. This will involve sending a due diligence questionnaire covering issues such as details of target’s property, main contracts, tax issues etc to the seller for its responses and/or it will involve the buyer reviewing a data room which will include relevant documentation relating to the target company.

The lawyers will carry out the legal due diligence and the accountants will conduct the financial, accounting and tax due diligence. The focus of the due diligence will depend on the nature of the target company.

On completion of due diligence, the buyer’s lawyers and accountants will produce due diligence reports in which they will highlight areas of concern and advise further action, such as a reduction in the purchase price and/or contractual protection for the buyer such as warranties and/or indemnities which should be included in the acquisition agreement.

The due diligence process is extremely important for the buyer (especially on a share sale due to the acquisition of all the liabilities, including hidden liabilities) and therefore the buyer should conduct a thorough investigation of the target company.

Acquisition agreement

Either during or after completion of the due diligence process the buyer’s lawyers will produce the first draft of the acquisition agreement for negotiation by the parties.

The main provisions in the acquisition agreement (whether structured as an asset sale or a share sale) will relate to the following areas:

1. Consideration – how much is the buyer going to pay for the target company / business? What form is the consideration going to take e.g. cash or shares in buyer, and when is it going to be paid? On a business sale, how is the consideration apportioned between the assets acquired?
2. Warranties – we have already mentioned warranties in relation to the results of due diligence investigations. Warranties are statements of fact which the seller makes in relation to specific aspects of target – the seller warrants that the statements are true and if they are subsequently found to be untrue by the buyer, the buyer will have a contractual claim against the seller for breach of warranty (subject to the usual requirements of loss, mitigation and foreseeability). Common areas on which warranties are given are accounts, employees, intellectual property, real estate, contracts and trading arrangements, disputes and taxation. The emphasis of the warranties will vary depending on the type of company being acquired. The seller’s liability for breach of warranty claims is usually limited by the vendor protection provisions and the contents of the disclosure letter.
3. Indemnities – again, we have mentioned indemnities in relation to the results of due diligence investigations. Indemnities are promises made by the seller to reimburse the buyer for any loss it suffers in connection with contingent liabilities. For example, on a share sale, if there is a customer of the target company who has threatened to bring legal proceedings against it, the buyer may ask that the seller indemnifies the buyer for the costs involved in defending any action brought as well as any resultant damages.
4. Vendor/seller protection provisions – vendor protection provisions are included in the acquisition agreement in order to limit the seller’s liability for breach of warranty claims. The provisions usually contain a time limit as well as an upper limit on any claim for damages that can be brought by the buyer (‘de maximus’) – usually, at most, the consideration paid by the buyer – and a lower level below which claims cannot be brought (‘de minimis’). The vendor protection provisions usually also contain a detailed procedure that must be followed by the buyer in order to bring a claim (including time limits for notification of claims).
5. Arrangements for completion – completion may occur at the same time as exchange of contracts (referred to as simultaneous exchange and completion). However, where a condition precedent needs to be satisfied (for example where consent to the transaction is required from shareholders, regulatory authorities or third party suppliers or customers) then exchange and completion will need to be separated with a time gap in between the two – this is referred to as split exchange and completion.

   The acquisition agreement will detail what issues need to be dealt with at completion, such as completion board meetings of the buyer and seller and the target company (as appropriate) and the agreements that need to be executed – this section can act as a good checklist for lawyers attending completion meetings of what needs to happen.

   Where there is a split exchange and completion, most of the practical steps to effect completion will take place at exchange (board meetings, signing most documents etc) and completion will usually be very quick (often done on the telephone) to confirm that everything that should have happened between exchange and completion has indeed happened and to transfer funds.

The key agreement in a share sale is called a Share Purchase Agreement (SPA). This agreement documents the sale of the shares of the target company to the buyer and confirms the consideration and other key provisions set out above.

Disclosure letter

It has already been stated that the seller’s liability for breach of warranty claims is usually limited by the contents of the disclosure letter. The disclosure letter is a letter written by the seller addressed to the buyer in which the seller sets out the details of any matters which make the statements of fact given in the form of the warranties untrue i.e. the disclosures qualify the warranties and as a result will limit the seller’s liability.

There are effectively two types of disclosure that can be found in a disclosure letter. These are:

1. general disclosures; and
2. specific disclosures.

General disclosures are disclosures which are usually found at the beginning of the disclosure letter (often referred to as the ‘front-end’ of the disclosure letter). General disclosures usually relate to searches of public registers that the buyer should do prior to completion such as searches of the Register of Companies and the Land Registry. The seller will usually seek to ensure that anything that the buyer could have found out by conducting such searches is deemed to have been disclosed. The buyer may seek to resist such general disclosures or may seek to make them as narrow as possible.

Specific disclosures are the disclosures usually found in the latter part of the disclosure letter (usually referred to as the ‘back-end’ of the disclosure letter). The specific disclosures are those that relate to the specific warranties given.

A large proportion of the time spent drafting and negotiating the acquisition agreement will be spent negotiating and drafting the warranties and the disclosure letter.

Other completion documents

There are also various other ancillary documents that may have to be
executed at completion or perhaps exchange (in the case of split exchange
and completion) as follows:

1. service agreements – for the directors/managers of target;
2. tax deed – comprising an indemnity from the seller to the buyer in relation to tax issues (only relevant on a share sale);
3. intellectual property licences/assignments – dealing with the transfer of important intellectual property rights such as trade marks;
4. novation/assignment agreements – for the transfer of third party contracts (only relevant on asset sales when contracts may be transferred from seller to buyer);
5. completion board minutes – for target, buyer and seller (as appropriate);
6. statutory forms (e.g. to notify Companies House of a change to target’s registered office, auditors or directors); and
7. transitional services agreement – if target was being provided with key operational services (e.g. HR/accounting/IT etc) by a parent or sister company prior to completion, the buyer may need those services to continue for a short period after completion. This is to ensure there are no problems with the continuity of trading after completion and to allow target to find an alternative supply of such services.

Who is liable under the warranties where there is more than one warrantor?

The parties giving the warranties are often referred to as the warrantors. You know already that there can be more than one seller which means that there can also be more than one warrantor. The buyer of the target company will usually insist, where there is more than one seller, that all sellers give the warranties on a joint and several basis.

Who does the buyer sue?

All the buyer is concerned about is that it will recover damages from somewhere. This is why the buyer will usually insist on joint and several liability so that it can sue (and recover against) any or all of the sellers and leave them to sort out the apportionment between themselves. A seller’s liability can take the form of any of the following:

1. Joint and several – Here, each seller assumes the obligation collectively (on behalf of all those bound) and individually (for himself). The buyer may then sue any one or more of the sellers for the whole or part of the loss.
2. Several – This is where each seller is liable for an agreed specified proportion of the potential damages. Here, the buyer must bring proceedings against individual sellers for their share.
3. Joint – The position is, in many respects, the same as if the parties were liable jointly and severally. However, the death of a party who is jointly liable will release his estate from liability. This has obvious disadvantages, both for the surviving sellers and for the buyer.

Joint liability also carries another disadvantage for the buyer – in order to bring proceedings against joint parties, the buyer must (subject to certain exceptions) issue proceedings against all of them.

‘Splitting the bill’

Civil Liability (Contribution) Act 1978

The Civil Liability (Contribution) Act 1978 entitles a joint warrantor who is found liable to pay damages for a breach of warranty, to seek a contribution from the others liable for the same damage. The court will evaluate the amount each of the parties should pay to the sued seller based on what the court considers just and equitable having regard to each party’s responsibility for the damage in question.

Express ‘Contribution Agreement’

Often the sellers will not want to leave it to the courts to decide the amount they should each contribute if the buyer is successful in a damages claim. So it is reasonably common for the sellers to agree between them a ‘Contribution Agreement’ to which they may refer should a successful warranty claim be made. They may agree, for example, that a minority shareholder, who does not have much involvement in the running of the company, will have a low cap set on any contribution (s)he may have to pay. Note that the existence of a Contribution Agreement does not affect the buyer’s right to choose who to pursue for a claim.

Again, much will depend on the specific circumstances of the deal in question (such as the bargaining strength of the parties and what the seller is willing to sell) but, just as with a share sale, there are advantages and disadvantages to structuring the transaction as an asset sale both from the perspective of the buyer and the seller. As a general rule buyers prefer asset sales.

Advantages for the buyer

When the buyer purchases shares in a share sale it also indirectly acquires all of the assets and more importantly the liabilities of the company. The effect of a share sale is that the buyer takes the company as it is – the target company retains all of its existing assets and liabilities – which could be a concern for the buyer if they are aware of certain significant liabilities of the target company.

On an asset sale, however, the buyer can decide what assets (and/or liabilities) it would like to purchase and what assets (and/or liabilities) it would like to leave with the seller. This can lead to a certain amount of ‘cherry picking’ by the buyer. There may also be certain tax advantages for the buyer depending on the nature of the assets the buyer is acquiring.

Advantages/disadvantages for the seller

An asset sale can be of great benefit to a seller if the company has a loss making or non-core division that it would like to sell whilst retaining more profitable parts of the business or more generally if the seller only wants to sell part of its business. Conversely, the main disadvantage for a seller is that on an asset sale it will be unable to transfer assets and/or liabilities that it no longer wants to the buyer unless the buyer wishes to purchase them.