How covid-help for distressed firms is hindering out-of-pocket contractors

While arguments rage over whether the government is doing the right thing to support enterprise from Covid-19’s ongoing impacts, one piece of action that officialdom has taken is worth a closer look, because unfortunately good intentions are giving rise to some rather grim consequences.

With thousands of commercial entities facing the threat of insolvency this winter, Whitehall has acted decisively to say that no business should face a winding-up order if it cannot pay creditors as a result of financial hardship caused by coronavirus or the fallout from it, writes Adam Home of Safe Collections.

Announcements, agreement, questions

This temporary measure was first announced by business secretary Alok Sharma in April, was enshrined in law in the Corporate Insolvency and Governance Act 2020 in June and, having been due to lapse at the end of September, was extended on the day of the Winter Economy Plan until the end of the year (December 31st precisely).

With England due to go into lockdown tomorrow, no one would argue against the spirit of protecting businesses from being wound-up at this most challenging of time. But questions remain about the balance which the government is striking with its moves.

Temp and Perm

The Corporate Insolvency and Governance Act is not just about giving Covid-affected businesses temporary breathing space in dealing with debts. In fact, it represents the biggest shake-up of UK insolvency law in 20 years, and the feeling in some quarters is that the government has used the Covid crisis to push through already existing policies in record time and without the usual level of scrutiny.

The Act contains changes to insolvency law that are permanent as well as those, like the winding-up petition ban, which are temporary measures relating to the pandemic. Taken as a whole, the mood behind the new rules is clear – government wants to take a softer approach to insolvency in a way that helps more companies from going under.

Which is all well and good. But where does that leave creditors, including SME suppliers and limited company contractors, struggling to recover legitimate debts from intransigent clients? And do the new rules give unscrupulous operators more room to wriggle out of paying debts?

The outlook for creditors

A run through some of the details of the Act doesn’t make great reading for creditors. One of the centrepiece changes, and a permanent one to boot, is the introduction of a new moratorium measure, which businesses can apply for to temporarily halt insolvency proceedings. These have existed before, but have been linked to specific insolvency arrangements. Previously a company could, for example, halt proceedings if it were in negotiations to enter administration or, for small businesses, a CVA.

But the new moratorium will be ‘freestanding’, so not linked to any specific insolvency arrangement. Instead, all that companies will need is a statement from a qualified insolvency practitioner that the ‘breathing space’ of up to 20 days (extendable to 40 days by agreement) is likely to result in a successful rescue plan being adopted, without detail of what that might entail.

A chilling effect

In the normal course of things, the moratorium is not available as a protection against winding-up orders. But as a temporary measure until the end of March 2021, companies will be able to apply for one even if they have been served with a petition by creditors.

Combined with the ban on winding-up orders against businesses facing Covid-related difficulties, this creates a significant, chilling effect on a significant legal recourse that creditors (like contractors) have to try to claim back monies they are owed.

The road to hell is paved with…

According to the letter of the regulations, creditors are still free to serve winding-up petitions. But anyone doing so before December 31st would have to demonstrate to the court either that the pandemic has not had a detrimental impact on the debtor’s ability to, or that the debtor would still not be able to pay regardless of Covid.

While not impossible, this becomes a very high-risk strategy. If the court takes a sympathetic view of the debtor’s plight in lieu of Covid and the petition is dismissed, the creditor may become liable for the debtor’s costs and/or damages for any losses arising from the presentation of the petition! When the debtor is allowed to then apply for a moratorium anyway even if the petition is accepted, it seems like even more of an undue risk.

A final rotten cherry on top of this unpalatable cake for creditors (where they are suppliers), is that the Act also imposes a permanent ban on the use of termination clauses which remove any obligation to keep supplying goods or services once a company becomes insolvent! So in other words, suppliers now have no choice but to keep supplying a struggling company, even if the chances of them ever getting paid for doing so are slim.

A small mercy is that small suppliers are exempted from this provision until March 31st 2021.

The Covid screen

Yet in the short term, should they be unable to recover monies owed by any other means, suppliers and creditors face major difficulties using the last resort mechanism of a winding-up petition against an insolvent debtor. You have to wonder how many unscrupulous operators will use Covid as a screen to hide malpractice, sitting behind the legal protections offered by insolvency to avoid responsibility for debts.

In the longer term, suppliers now face a future where they have no choice but to continue to supply goods and services even once a client becomes insolvent. The obvious danger is that the good intention to give one business every chance to survive will lead to even more business failures further down the supply chain.