The Government on the 3rd of April proposed some legislative changes to the Companies Act in order to support business that are struggling due to the COVID-19 lockdown.
One of the more interesting changes was the proposal to allow business to place their debts into hibernation.
So, what is “Business Debt Hibernation”?
Exact details aren’t known at this stage, but the intention of the regime is to;
- Encourage directors to talk to their creditors with the view and intent to place the business into hibernation.
- Allow the directors to retain control of the company rather than passing control to an insolvency practitioner.
- Provide certainty to new creditors that they won’t have to repay any money they receive, so as to encourage businesses to continue trading with entities in Business Debt Hibernation.
- Be easy to implement so businesses can apply it to their own situation without the need for legal advice.
So, how do you place your business debt in hibernation?
Well, the regime appears to need to allow creditors to vote, one assumes in a similar way to, for example, a DOCA (Deed of Company Arrangement) in a Voluntary Administration.
However, a company only needs 50% of their creditors to approve a debt hibernation (by number and value) which makes it easier to obtain the relief. All creditors will have one month to make up their mind.
So, how long does it last?
Once the creditors are notified of the intention to place the business debt in hibernation, none of the creditors can seek to enforce their debts for one month.
If the proposal is accepted, then the company gets a further 6 months where creditors cannot enforce their debts.
Its also binding on all creditors, even those that voted against it or didn’t vote at all. However, it isn’t binding on the businesses employees and is subject to any conditions the creditors insist on.
Can the company continue trading?
Yes, but subject to any restrictions placed on it by its creditors.
In fact, in order to encourage other companies to trade with it, it is proposed that any further payments made by the company to its creditors on new trading debts, be exempt from the voidable transaction regime. While this exemption wouldn’t extend to related parties, it would give comfort to new creditors that a liquidation, if one is appointed later, wouldn’t be able to claw back the funds they’d received.
It should be noted that related party debts are not included in this exemption.
My business isn’t a limited liability company. Is that a problem?
No, any entity can seek to place its debts into hibernation under this scheme unless you are a licenced insurer, a registered bank or a non-bank deposit taker, or a sole trader.
What about directors’ duties?
The whole concept about this is to provide businesses with, what the Government is calling, a safe harbour. There is a specific exclusion to sections 135 and 136 of the Companies Act 1993 for any director who is allowed to take advantage of these benefits.
What’s the catch?
The business must have been solvent at 31st December 2019 and the directors would be wise to ensure that’s the case. The directors must also consider that, in good faith, that the business will be able to pay its debts as they fall due within 18 months and believe the issues being faced now, or in the next 6 months, are as a result of the impact of COVID-19.
If it is proved, at a later date, that the above criteria are not met, then the directors may still be liable for breach of directors’ duties.
This is an interesting regime that may provide benefit to some businesses. Will many businesses be able to take advantage of it and will it provide a benefit when it only gives a 6-month breathing space? Only time will tell.
There are a few unanswered questions though. For example;
- Do different creditor classes have to vote separately and, if so, what happens if one class of creditor votes against the proposal? It would be unfortunate, for example, if secured creditors lose their rights via this process but also unfair if one class of creditor can dictate the process.
- What happens if directors fail to notify a creditor? Are they bound by the voting outcome?
- The concept appears to be that the debts are frozen at a point in time, but it is unclear exactly what that time is. One assumes it will be at the date the proposal is put forward.
There seems to be significant risk falling on the directors. If they make a mistake during the process, for example, fail to notify a creditor or miss a creditor from the list entirely, they may find themselves in a difficult position.
While the process is intended to be manageable by the directors themselves, it may prove sensible for them to take appropriate independent advice from an accredited insolvency practitioner.
Any business considering this option should also look at the other statutory options available and weigh up the pros and cons of each. Each option has its own unique advantages and disadvantages. Choosing the right option for your business is vital.