Changing insolvency legislation to limit the economic impact of coronavirus - robbing Peter to pay Paul?

The Government has announced further measures to limit the shock of coronavirus on the economy, introducing plans to restrict the use of Statutory Demands and Winding Up Petitions for commercial rent arrears.

The Government has already deferred VAT payments and introduced loan schemes and the furlough scheme to provide credit to struggling businesses and limit redundancies. It has also taken steps in the Coronavirus Act to prevent commercial landlords from forfeiting leases for non-payment of rent, in an effort to prevent restaurants, pubs, retail businesses and others losing control of their premises if they can't pay rent during the lockdown. 

Despite those measures rent is still due, but many tenants have stopped or delayed making payments to landlords whilst they are not generating any income.

Commercial landlords and tenants have been expressing their concerns about this in the press. Tenants are concerned about paying significant rent bills whilst stores are closed, and landlords are insisting that they need the money to pay their own staff, mortgages and other expenses.

Although rent is a significant cost for retailers, businesses of all sizes and across all sectors have slowed or stopped payments to suppliers, in order to maintain cash flow. Failing to pay has a knock-on effect throughout the supply chain and risks many more businesses suffering cash flow difficulties, and being unable to pay their own bills.

Statutory Demands and winding up 

If a company owes an undisputed debt of more than £750 to a creditor, the creditor can serve a Statutory Demand on the company, requiring that debt to be paid within 21 days. If the debt is not paid (or otherwise settled or secured) within that period, the creditor can petition the court to wind up the company, seeking an order that it be placed into compulsory liquidation.

The creditor can point to the unpaid Statutory Demand as evidence that the company cannot pay its debts as they fall due, and is therefore insolvent. If the Court winds up the company, it will appoint a liquidator to collect in and distribute the assets of the company, for the benefit of all of the company's creditors.

The presentation of a petition itself, before any hearing of that by the Court, can cause the company's bank accounts to be frozen, contracts to be terminated and its reputation to be damaged. So the risks of ignoring a Statutory Demand are significant and give much power to creditors.

The proposals

The Government announced on 23 April that:

• it will temporarily ban the use of Statutory Demands and Winding Up Orders where a company cannot pay their bills due to coronavirus, to ensure they do not fall into deeper financial strain
• any winding up petition that claims that the company is unable to pay its debts must first be reviewed by the Court to determine why
• the law will not permit petitions to be presented, or Winding Up Orders made, where the company's inability to pay is the result of Covid-19

It is unclear whether these proposals are to apply to all debts owed by a company, or just those between commercial landlords and tenants (which seems most likely in the context).

The details

The plans are not yet law and the details remain unclear. So at this stage any tenant with outstanding debts is still at risk of being wound up by a creditor; though that position could change quickly and makes any action by landlords risky.

The Government previously announced proposed changes to insolvency legislation to suspend wrongful trading provisions. Although those changes are supposed to be retrospective, they haven't yet been introduced. A similar delay with the above mentioned proposals could be problematic, particularly if there is uncertainty about whether the legislation will only relate to liabilities incurred moving forward, or whether it is intended to cover debts already incurred, and how far back any retrospective period will extend.

Since making the initial announcement the Government has added some detail, saying that there will be a "temporary ban" on the use of Statutory Demands (made between 1 March 2020 and 30 June 2020) and winding up petitions presented from Monday 27 April, through to 30 June, where a company cannot pay its bills due to coronavirus. The measures will be included in the Corporate Insolvency and Governance Bill, which is expected to be brought into law in the next couple of weeks.

There is still a lot of further detail and clarification required about the announcement.

What does it mean for landlords?

It seems clear that the Government wants to extend protection for commercial tenants and to avoid landlords threatening insolvency if companies cannot pay rent when it is due because of the lockdown.

Whilst the logic behind that makes sense for the wider economy, it is a significant restriction on a landlord's rights. The Government is encouraging tenants to "pay rent where they can afford it or what they can in recognition of the strains felt by commercial landlords", but these changes seem to lean significantly in favour of tenants, putting a hold on a landlord's right to recover money due.

What does it mean for tenants?

The changes might give businesses that are under pressure to pay rent some breathing space, especially when combined with other restrictions on landlords' rights such as the prohibition on forfeiture and the (newly proposed) restrictions on Commercial Rent Arrears Recovery.

The scale of the impact depends on the small print of the legislation.

In any event, as soon as the restrictions come to an end, the tenants will face arrears of rent and will be facing a new cash-flow problem.

Insolvency

Companies that are struggling to pay debts, now or in the future, will need to consider the solvency of the business.

A company is insolvent if:

1. it can’t pay its debts as they fall due (the cash flow test); or
2. its total assets do not exceed total liabilities (the balance sheet test).

As more businesses stop making payments, more and more companies will fail the cash flow test.

An unpaid Statutory Demand essentially proves that a company has failed that test. It is unlikely the Government's proposals will extend beyond debts for commercial rent, so the use of Statutory Demands in other sectors is likely to continue.

So companies will generally still be expected to pay their debts as they fall due, and that is why the Government's other financial stimulus packages are designed to inject cash into the economy. During these unprecedented times there will inevitably be strains on cash flow, and the long term viability of a business will remain a problem until cash begins to move through the supply chain.

The Government has already announced measures, including the suspension of wrongful trading provisions, to encourage company directors to trade through short-term cash flow problems - but as mentioned above, that has not yet been introduced and directors are still exposed to a range of personal risks when a company faces insolvency, aside from wrongful trading. Directors should therefore consider the long-term viability of the business, it's liabilities to creditors and do everything they can to maintain cash-flow.