One of the most important post-Covid-19 questions: how should insolvency law operate?

During this early phase of the Covid-19 crisis, the government’s support for businesses has rightly focused on preserving workforces, deferring liabilities and improving access to cash. But this has merely kicked the fizzing can of debt down the road. It seems likely that, once the lockdown ends, huge numbers of businesses will survey the scene and find that, despite government assistance, they have accumulated hopelessly unpayable debts.

At that point, the operation of the insolvency laws will do much to determine the future of the economic landscape and whether a depression has been avoided or merely postponed.

But those laws were not designed for anything like the present shock. It is clear that the goal ought to be to save otherwise good businesses that have been struck down by the Covid-19 storm. Achieving that will involve a combination of the innovative use of existing legislation and the implementation of new statutory measures.

For some time, the trend of policy has rightly been towards promoting rescue whenever distressed businesses are fundamentally sound, while keeping the costs of entrepreneurial failure within reasonable bounds. That encouragement of enterprise and risk-taking, though, has always needed to be balanced against the need for a stable and predictable environment for providers of credit.

In the perennial trade-off between the interests of creditors and debtors, the UK’s insolvency laws are still generally perceived as friendly to the former, in contrast to the more debtor-friendly regime across the Atlantic. A smart initiative led by the insolvency profession has sought to tilt the balance within the framework of existing legislation. In the immediate pre-Covid-19 era, high-profile insolvencies of the likes of Carillion and BHS cemented the link in the public mind between the administration procedure and business failure. In origin, though, the focus of administration (in contrast to liquidation) was on rehabilitation, affording temporary protection from enforcement by creditors while an insolvency professional restructured the business.

A new “light-touch” form of administration is designed to restore the procedure to its rehabilitative roots. This is the method that has recently been adopted for Debenhams: although administrators have been appointed to the company, the existing management will remain in place under their supervision. The effect of the administration is still to afford the company a period of respite from its creditors. While the Debenhams case is a prominent trailblazer, the procedure has been designed with the needs of small- and medium-sized enterprises particularly in mind, aiming to minimise court involvement and keep costs low. It is also an approach which takes a significant step in the direction of the Chapter 11 bankruptcy procedure that is long-established in the US.

The fact that it has been fashioned within the context of existing legislation imposes limitations. Insolvency officeholders remain responsible to creditors and the court for supervising the company’s affairs: some have said that delegation to existing management in this way is too risky to contemplate. Statutory amendments in the short term could enhance the prospects for the procedure, while other measures that had already been mooted by the government, such as a new temporary moratorium from debts, also have renewed appeal.

Yet as the full shape of the devastation wrought by this crisis becomes clearer, more heavy-handed interventions in the relationship between debtors and creditors may also prove justified. Insolvency processes have always sought to achieve an orderly and fair division of available assets among creditors, rather than the disorderly scramble which would otherwise ensue. But there has been nothing fair or ordered about the differential impacts of the lockdown and the government support package across the economy.

This supports the case for exceptional measures. “Light touch” is premised on a world in which creditors will be accommodating enough so that the pain of losses is sensibly shared and good businesses are enabled to carry on. Yet not all creditors will be prepared to look at the bigger picture. Sharing the pain as equitably as possible may require laws making it easier to force their hand. In the pre-Covid-19 world, such a shift would have been considered objectionable for the risks it poses to future willingness to extend credit. But the mandate of allowing businesses to re-emerge from the scorched undergrowth may trump such concerns.

Rescue measures would ideally sort the good from the bad and target only the former, but such distinctions can be hard to draw. The government’s announcement of its intention to suspend the wrongful trading rules (making directors liable for continuing to incur company debts when it should have been clear that it was sunk) illustrates the point: many critics observed that the measure risked offering a carte blanche to directors of companies still destined to fail.

Measures like this are necessarily blunt instruments which help weeds as well as good seeds to grow. Yet that will be a lesser price to pay than allowing a domino rally of liquidations and the disappearance of swathes of formerly profitable activity, from which British business could take decades to emerge.

 

James Mather is a barrister at Serle Court specialising in insolvency, fraud and company litigation