2019 Restructuring and insolvency review
Whilst the political certainty, which will hopefully result from the election outcome of December, may lead to increased confidence in the economy, there are a number of potential headwinds which businesses will need to navigate during the year and it is inevitable that not all will do so successfully. With that in mind, it is helpful to look back at the key themes of the market in 2019, and also to look forward to what 2020 may bring.
As a whole, the UK economy has managed to weather the political disruption throughout the year fairly well. There are however, as one would expect, certain sectors which have fared worse than others. The high street continues to endure a period of transition where traditional bricks-and-mortar businesses face increasing pressure from competitors whose primarily online offering, and resultant lower cost base, allows them to be extremely aggressive on pricing. As technology develops, the attraction to consumers of the ease of purchasing online steers more and more activity away from the high street – why brave the rain on Oxford Street in December when you can order from Amazon and receive your purchase to the comfort of your home or office on the same day?
As a result, 2019 saw a number of high-profile retailers either use company voluntary arrangements (CVAs) as a means to reduce their rent payments to landlords and off-set reductions in trading income or enter into administration where they had run out of other options. The use of CVAs by retailers to reduce rents has been a feature of the market for a couple of years now, however statistics produced by the Centre for Retail Research confirm that 42 retailers entered administration or liquidation during 2019, which caused 2,041 store closures and affected around 46,000 employees. Certain of those businesses (Mothercare and Regis being two notable examples) had entered into CVAs prior to going into administration, indicating that even where rents can be reduced by CVAs, trading conditions may be so difficult that administration or liquidation become unavoidable. Whilst it’s too early to say whether 2020 will face a similar number of failures, reports indicate that footfall on the high street over the Christmas period has dipped since 2018 and that trading conditions continue to be challenging. Whilst the Government has indicated that it is likely to take steps to provide some relief (cuts to business rates being the most likely) it is reasonable to assume that without fairly significant intervention the sector’s difficulties are likely to continue.
In addition to retail, a number of other sectors began or continued to show signs of distress over the past 12 months. The auto industry, for example, is faced with pressure regarding emissions levels and the gradual conversion from petrol to electric cars (for which fewer components are required), the increased prominence of ride-sharing apps like Uber and trade tensions each causing sales to dip. Given these factors, it appears unlikely that 2020 will bring much respite for the industry. Further, consumer finance businesses continue to face challenges and increased regulatory scrutiny – for example, crowd-funding platforms and retail-bond issuers have both come under the FCA’s microscope over the past 12 months, which is likely to cause failures during 2020.
The increased use of CVAs by retailers to cut their rents has continued to cause controversy in the landlord community during 2019 and has led to a number of high-profile CVAs being subject to challenge by landlords. The judgment regarding the challenge to the Debenhams CVA was handed down in September and whilst four of the five grounds of the challenge failed, the judgment did provide that a CVA cannot vary a landlord’s right of re-entry and therefore that a CVA is not able to remove or alter a landlord’s right to forfeit. Whilst this is helpful to landlords, the judgment read as a whole still seems to support the view that the court has largely, for the time being, supported the use of CVAs to compromise sums due to landlords without the other creditors of the company being compromised. It is therefore likely that CVAs will continue to be used in this way for the foreseeable future. Whilst landlords are unlikely to stop looking to challenge CVAs entirely, the Debenhams judgment may give pause to some landlords when considering challenges and it may therefore be the case that landlords are more amenable to consensual negotiations to reduce or restructure rents when the alternative is the, now highly tried-and-tested, prospect of a rent cut imposed by a CVA. We therefore expect to see more retailers (and perhaps businesses in other sectors) looking to renegotiate leases in this manner in 2020.
A move to universalism?
In August 2018, the Government announced reforms which, if introduced, could amount to the biggest shake-up of the UK’s insolvency and restructuring framework since the 2002 Enterprise Act. Whilst the process for implementing the reforms is ongoing (and it was noticeably absent from the Queen’s speech), and some aspects may be dropped as the process takes shape (for example, the proposed introduction for liability of directors of holdings companies in relation to sales of insolvent subsidiaries was met with a generally negative response and is likely to be significantly amended, if not removed altogether, from the proposals), the reforms represent an attempt to introduce processes into English law which look very similar to aspects of US chapter 11 bankruptcy proceedings. Whilst there are multiple reasons for the reforms, the move to a more chapter 11 style system (or at least parts of it) is a direct response to a general transition of the insolvency laws in a number of jurisdictions to a more universal set of principles and norms based on chapter 11. This transition is also evident in the EU’s directive on ‘preventive restructuring’ which was issued in 2019 and which seeks to reform the insolvency systems in each EU member state so that each adopts a more standardised set of procedures based on chapter 11.
Whilst the benefits of universalism and the certainty of a standardised set of insolvency and restructuring processes across a number of jurisdictions are obvious, the manner of doing business in one jurisdiction may be very different to another and therefore require a different approach when seeking to deal with insolvent businesses. In the UK’s case, English law insolvency and restructuring processes are commonly used by businesses situated all over the world and market practitioners have tailored and developed those processes to enable pretty much any type of business to be effectively restructured via English law – CVAs being used by retailers in the manner described above being one of many examples. Consequently, an element of resistance to any widespread change to English law which risks prejudicing the UK’s position as a preferred forum for cross-border restructurings and insolvencies can be expected during the coming year (and indeed beyond). This is particularly the case in light of the fact that, a number of European jurisdictions have, or are in the process of, introducing restructuring processes which closely mirror English law scheme of arrangements, which presents a potential challenge to the UK’s position as the form of choice for large, complex restructuring.
Liquidation and special managers
Whilst the first high-profile insolvency appointment to be made by way of a compulsory liquidation with special manager took place in 2018 in relation to Carillion, 2019 saw the trend continue with British Steel and Thomas Cook doing the same, which involves the Official Receiver (a representative of the Insolvency Service) being appointed as liquidator with a private firm of insolvency practitioners being appointed as special managers to assist with the day-to-day running of the process. The willingness of the government to step in and for the Official Receiver to act as liquidator in this manner reflects the public importance of each business which has used the process so far, and whilst it is unlikely that a large number of appointments of this nature will be used in the future, it does provide the government with a way to become involved with, potentially sensitive insolvencies whilst ensuring that professionals with extensive expertise are responsible for their conduct.
Consequently, should a similar business face difficulties in 2020 a liquidation of this type, rather than administration, is likely to feature. That said, arguably this approach is evidence of a weakness in the existing insolvency regime and so could become part of the insolvency reform agenda itself.
The B word
At the time of writing, it appears certain that the UK will leave the European Union on 31 January 2020. Whilst Brexit may therefore be “done”, the specifics of the UK’s future trading relationship with the EU remain unresolved. The Withdrawal Agreement between the UK and the EU will maintain the effectiveness of the EU’s Insolvency Regulation during the transition period which will end on 31 December 2020. This will allow the continued mutual recognition of insolvency processes between the UK and the EU (except for Denmark which has opted out of the Insolvency Regulation). Whether this will continue beyond 31 December 2020 will depend on what agreement the UK and the EU reach during the transition period. If no deal is reached the UK intends to retain the test for jurisdiction of main insolvency processes based on the location of a company’s centre of main interest (COMI) as per the EU’s Insolvency Regulation. However, the UK courts’ insolvency jurisdiction would not be limited to the COMI test and main insolvency proceedings could be opened in the UK even if a company’s COMI is in an EU member state. The UK’s increased flexibility on recognition of insolvency processes would be countered by the loss of automatic recognition of UK insolvency proceedings across the EU. Instead, recognition of UK insolvency processes will depend on each EU member state’s domestic law. The UNCITRAL model law on cross-border insolvency, which also provides for a COMI based system of recognition of insolvency processes, has only been adopted by a few EU member states (Greece, Poland, Romania and Slovenia) so a failure to reach agreement on recognition of insolvency processes after the transition period will likely lead to greater uncertainty and costs for pan-European insolvencies.