Insolvency, Partnership & Company Law – A Lifeline for Small Companies

By : Sara Benbow

The new moratorium provisions for small companies proposing CVAs.

Insolvency, Partnership & Company Law

The Company Voluntary Arrangement procedure introduced by Part I of the Insolvency Act 1986 has proved a relatively popular option for an insolvent company wishing to attempt to negotiate and trade its way out of a difficult situation. Insolvency Service statistics show that in recent years approximately 550 CVAs have been agreed annually.

However, one significant omission from the 1986 Act voluntary arrangement procedure for companies was any provision for interim protection against creditors whilst the directors’ proposal is being prepared and considered by the creditors’ meeting.

This differed from the situation in respect of Individual Voluntary Arrangements under Part VIII of the 1986 Act. By virtue of s.252-3 any individual debtor who intends to make a proposal for an IVA to his creditors may apply to the court for an interim order preventing, during the period in which that order subsists, (i) the presentation of a bankruptcy petition against him or (ii) the commencement or continuation of any proceedings, execution or other legal process against him or his property without the leave of the court. An application can even be made under s.254 for a stay of any action, execution or other legal process against the debtor or his property pending the determination of his application for an interim order.

An interim order in respect of an individual under s.252 may be made if the court considers it appropriate and is satisfied:

1. that the debtor intends to make a proposal for an IVA
2. that he was an undischarged bankrupt or able to petition for his own bankruptcy on the day he made the application
3. that he had not applied for an interim order within the previous 12 months and
4. that there is a qualified IP willing to act as nominee in respect of the proposal. [i]

The purpose of the interim order is to give a breathing space in which the proposal can be prepared and thereafter considered without one or more creditors seeking to pre-empt matters by taking their own steps to chase a particular debt.

The justification for providing this form of protection for an individual debtor but not for a corporate one has always been a little difficult to understand. Section 1 and Schedule 1 of the Insolvency Act 2000, which received Royal Assent on 30 November 2000, were intended to address this in respect of small companies (as defined in s.247(3) of the Companies Act 1985 [ii]). According to the Explanatory Note to the 2000 Act, it provided for small companies in financial difficulties to be more readily able to make voluntary arrangements with their creditors by giving the option of a moratorium to give the directors time to put a rescue plan to creditors and for minor modifications to be made to the provisions relating to the existing company and individual voluntary arrangement schemes and the administration order procedure. The Note also observed, correctly, that the absence of any moratorium in respect of a potential CVA meant that, until the arrangement was formally approved, any creditor could take legal action against the assets of the company and so jeopardise the prospects of the voluntary arrangement succeeding. The addition of an optional moratorium to the CVA procedure was intended to offer the directors and management of a small company a short time within which to put a rescue plan to creditors.

However, the relevant parts of the 2000 Act were left without implementation, and the proposed moratorium was therefore not made available to corporate debtors, regardless of their size.

That unfortunate position has at last been changed with effect from 1 January 2003. The Insolvency Act 2000 (Commencement No. 3 and Transitional Provisions) Order 2002 [SI 2002 No. 2711] brought into force the balance of the 2000 Act on that date. Therefore, in respect of any proposal not endorsed by the intended nominee prior to 1 January 2003, the directors of the small company will be able to seek a moratorium under the new s.1A of the 1986 Act.

The principles and effects of and procedure to be followed on such an application are contained in the new Schedule A1 to the 1986 Act. Note that a small company is excluded from being eligible for a moratorium if on the date that documents in support of the application are filed it is in administration, being wound up, in administrative receivership, subject to a voluntary arrangement, has a provisional liquidator in office, has been subject to a previous moratorium under s.1A during the past 12 months which didn’t produce a CVA or in respect of which the CVA ended prematurely, or a CVA proposed in the context of administration or winding up ended prematurely and during the past 12 months there had been a stay or sist order under s.5(3)(a).

The simple procedure which must be undertaken in order to obtain a moratorium under the new provisions is as follows:

1. The directors must submit their proposal to the nominee and the nominee thereafter provides a statement of his opinion as to whether or not the proposal has a reasonable prospect of being approved and implemented, whether there are likely to be sufficient funds available for the business to be carried on, and whether meetings should be summoned [para 6].
2. The directors then file with the court certain prescribed documents including the nominee’s statement [para 7(1)]
3. The moratorium begins automatically upon filing those documents [para 8(1)] and ends at the end of the day on which the first meetings of the creditors and the company are held to consider the proposal unless it has been extended [para 8(2)]. If the meetings have not been held within 28 days of the beginning of the moratorium and there has been no extension, the moratorium ends at the end of the day when the meetings should have been held [para 8(3)]. It will end in any event on the day that a CVA is approved.

Once the documents have been filed with the court the directors are obliged to notify the nominee [para 9] who must then advertise the fact that a moratorium is in force and notify the registrar of companies, the company itself and any petitioning creditor of whose claim he is aware [para 10]. Similarly, when the moratorium comes to an end the nominee must advertise and notify the court, the registrar of companies and any creditor of that fact [para 11].

The effects of the moratorium are spelt out in Part III of Schedule A1 [paras 12 – 23]. They extend far beyond a simple general prohibition on legal proceedings and execution or other legal process. They include, for example, limitations upon the company’s ability to obtain credit or grant security and provisions as to the non-crystallisation of a floating charge.

During the moratorium the nominee is to monitor the company’s affairs in order to form a view as to whether the proposed CVA with any proposed modifications has a reasonable prospect of being approved and implemented and whether the company is likely to have sufficient funds to enable it to carry on its business during the remainder of the moratorium [para 24]. If he forms a negative view in respect of either of those matters at any time then he is obliged to withdraw his consent to act as nominee and notify the court accordingly [para 25]. Upon the nominee’s withdrawal of consent to act the moratorium automatically comes to an end [para 25(4)]. Any act, omission or decision of the nominee during the moratorium (including a decision to withdraw his consent to act thus terminating the moratorium) may be challenged by any creditor, director or member of the company or any other person affected by the moratorium by application to the court [para 26].

The acts or omissions of a director of the company during a moratorium may also be challenged by any creditor or member of the company on grounds of unfair prejudice [para 40], and the court is given wide powers to regulate the conduct of the directors or to bring the moratorium to a premature end. New offences are created by paragraphs 41 and 2 in respect of the conduct of any officer of the company during a period when a moratorium is in force or undertaken for the purposes of obtaining or extending a moratorium.

The implementation of these final parts of the Insolvency Act 2000 will have a significant impact upon small companies in difficulty. The effects of the Enterprise Act 2002 and its emphasis on the use of administration orders to control insolvency situations have been addressed elsewhere, but the availability of a formal and automatic moratorium will make the CVA a real and attractive alternative to administration or winding up for most small businesses. It is a welcome lifeline in otherwise uncertain times.

References

1. S.255 Insolvency Act 1986
2. Section 247(3) Companies Act 1985 defines a small company as one which satisfies two or more of the following criteria:
   1. Turnover – not more than £2.8 million.
   2. Balance sheet total – not more than £1.4 million.
   3. Number of employees – not more than 50.