COVID-19: Holding the line – Standstill agreements and Moratoria

In Bermuda, the Companies Act 1981 (Companies Act) does not define or use the terms ‘solvency’ or ‘insolvency’, but rather refers to a company being ‘unable to pay its debts’.  A company will be deemed to be unable to pay its debts if:

• the court is satisfied that the company is unable to pay its debts taking into account the contingent and prospective liabilities of the company (a cash flow test) or where the realisable value of the company’s assets is less than its liabilities (a balance sheet test);
• the company fails to discharge an undisputed statutory demand exceeding five hundred Bermuda dollars within 21 days; or
• where execution of a judgment or order against the company is returned unsatisfied.

In the present difficult circumstances of the Covid-19 pandemic, where many businesses have been significantly affected and their cash flow disturbed, pressure is building on companies that are skirting the edge of the ‘zone of insolvency’, i.e. those companies unable to pay their debts due to temporary liquidity constraints or debts falling due in the near term (contingent debts).

What options do the boards of directors of Bermuda companies have in these circumstances?

STANDSTILL AGREEMENTS

Where an event of default under a loan agreement has already occurred, or where it is likely to occur in the future due to cash constraints on the company, the company and its creditors can enter into a standstill agreement to suspend either the creditor’s rights of enforcement (if the default has already occurred) or the obligations of payment (if default will otherwise occur in the near future).  This will be an entirely consensual private contractual arrangement between the creditors and the debtor company.

There is no particular specified form that a standstill agreement must take in Bermuda, but it will need to follow usual common law contractual principles; there will need to be mutual benefit to the parties to the agreement and the agreement must have the certainty of a specified period (‘the standstill period’).  The agreement should also fix the amount of debts owed to the creditors of the company as at a particular date (the ‘standstill date’).

Standstill agreements will frequently be relatively short in duration (often two to three months), usually at the creditors’ insistence in order to allow them to maintain leverage.  It is common for agreements to be extended by mutual consent where genuine progress is being made, although the negotiation of extensions is likely to involve demands from creditors for additional enhanced levels of information provision or other covenants.

STATUTORY MORATORIUM

The statutory moratorium in Bermuda represents a prohibition of legal proceedings being continued or commenced against the debtor company without leave of the court and occurs on the appointment of a provisional liquidator following the presentation of a winding up petition.

This can arise in two ways.  Firstly, where a petition has been presented and a petitioning creditor, often supported by a group of creditors, applies for the appointment of a provisional liquidator on the basis that there is a risk of dissipation of the company’s assets if the board of directors is left in place. In this scenario, the order of appointment removes the board, management of the company is transferred to the provisional liquidator and the moratorium automatically takes effect to protect the company from action by other creditors (albeit not secure creditors – see below).

The second means is restructuring focussed.  As Bermuda has no direct equivalent to administration proceedings in England and Wales or to US Chapter 11 proceedings, this legislative gap has been filled by the practice of the Bermuda Supreme Court over the last two decades in imaginatively interpreting its power to appoint liquidators under the Companies Act to include the power to appoint provisional liquidators for restructuring purposes.  This is a particularly useful option for a Bermuda company where the directors believe that the company is viable and there is a high degree of creditor support for restructuring of the company’s debt, but not all the creditors are signed up to this approach or can be persuaded to enter into a standstill agreement.

In this form of ‘light touch’ provisional liquidation, a petition is presented by the company (exceptionally it could be by a creditor), an application is made for the appointment of a provisional liquidator, and upon that appointment, which will be with limited powers (typically to monitor and advise on restructuring options), the board of directors remains in place to deal with the day-to-day management of the company and to lead the restructuring.  The scope of this form of provisional liquidation has proven to be quite wide and has been used (without the grant of a winding up order):

• to promote a scheme of arrangement on behalf of a company whereby the company makes a compromise or arrangement with its members and/or creditors pursuant to section 99 of the Companies Act;
• with very limited powers to oversee the actions of the board of directors while parallel Chapter 11 or Chapter 15 proceedings are pursued in the US; and
• to explore other restructuring options such as an equity injection by a ‘white knight investor’ or a purchase of distressed debt by a third party.

Regardless of the form of restructuring, the company obtains the benefit of the statutory moratorium during the period that the provisional liquidator is in office.  Without the threat of legal proceedings from dissenting minority creditors, the company gains the time and space to concentrate on its restructuring objectives.  The benefit to creditors is that the company is now operating under the supervision of a provisional liquidator and the court.  While it is not for the provisional liquidator to determine the form of restructuring, it is often helpful to a have an independent third party monitoring and assisting in the process.

Whether the proceedings are company or creditor led, the procedure is the same.  A petition is filed and an urgent application, usually made without notice, is filed for the appointment of a provisional liquidator.  The moratorium comes into effect on appointment.  Where the petition has been filed for restructuring purposes, the proceedings will be adjourned.  It should be noted, however, that the moratorium does not impact the rights of secured creditors to enforce their security against the company provided that they can rely upon ‘self-help’ provisions contained in the relevant security documents and do not require recourse to legal proceedings to do so.

The BVI is often described as a creditor friendly jurisdiction. Although the BVI enacted an administration regime in the Insolvency Act 2003, almost two decades later those provisions have not been brought into force. No automatic moratorium exists outside of a formal liquidation process, and even then the right of secured creditors to enforce their security is specifically preserved. There is also no formal route to preventing the presentation of a winding up petition.

Despite this, restructuring tools do exist outside of a formal winding up process:

• Negotiated debt restructurings, often accompanied with the provision of further security, are common. Standstill agreements are occasionally also deployed.
• A scheme of arrangement can be proposed under Section 179 of the BVI Companies Act 2004.
• Provisional liquidation is sometimes used as a means to effecting the pre-packaged sale of subsidiaries and other company assets. This would typically involve a period during which the company’s management undertakes a valuation and sales process in consultation with the proposed liquidator or provisional liquidator, often before the formal appointment takes place.
• Where winding up proceedings are commenced, the starting point is that an unpaid creditor whose debt is not the subject of a genuine and substantial dispute will usually be entitled to succeed on its winding up application, unless special reasons are shown. The Court will, however, in an appropriate case be prepared to adjourn a winding up petition or to stay the proceeding if it is satisfied that a restructuring technique would provide a better return to the general body of creditors.
• Although the point has not yet been tested, it may be possible for the Court to seek the assistance of a foreign court and to invite it to take advantage of any administration or similar regimes there.

None of these techniques is associated with any form of automatic moratorium, until liquidators are appointed and a winding up order is made. However, Section 174 of the Insolvency Act 2003 permits the Court to stay existing proceedings in the BVI. As the recent decision in Constellation Overseas (BVIHCM 2018/0206) shows, the appointment in that case of a so-called “soft touch” provisional liquidator also offers a route to staying existing proceedings, and for the provisional liquidator to seek recognition and assistance in other jurisdictions where a moratorium may be available.

The test for insolvency in the Cayman Islands is a cash flow test, rather than an assessment of whether the company has net assets or net liabilities (balance sheet solvency/insolvency).  The pressure point for Cayman companies that are approaching the zone of insolvency is therefore liquidity: cash to pay current debts or debts falling due in the near-term (contingent and prospective liabilities).  As a result, it is common for companies of high asset value to be at risk of creditor action due to liquidity issues, whether short-term or more systemic.  In the present environment, where Covid-19 has and continues to wreak havoc with business, companies are at increased risk of finding themselves dealing with unforeseen cash-crunches.  It is therefore important that boards of directors and creditors be well-apprised of options that are available to them to minimise the impact of such a scenario and to buy sufficient time to put a workout of some kind in place.

STANDSTILL AGREEMENTS

Given the severity and depth of the challenge to business that Covid-19 represents, parties with creditor-debtor relationships may well take a consensual approach to the unique circumstances before them, as we have seen, with mortgage payment holidays, and the like.  Where it is possible for a debtor and creditor to reach broad agreement on an arrangement between them, this will often take the form of a standstill agreement.

If an agreed standstill period expires, but the creditor is satisfied that the company has made bona fide efforts to overcome its liquidity challenges and funds are expected reasonably soon to discharge the creditor’s debt, it is not uncommon for a standstill agreement to be rolled over and a new period of forbearance to be agreed, perhaps with more onerous conditions; for example, creditors can press for greater transparency and/or for a covenants that no dispute will be raised about the debt in winding up proceedings, should they be required.

STATUTORY MORATORIUM

By contrast with the above contractual arrangement between a single creditor or group of creditors with the debtor company, a statutory moratorium may be obtained (i) by the company by an application for appointment of provisional liquidators on the basis that the company intends to present an arrangement or compromise to its creditors, or (ii) by a single creditor or group of creditors by an application for appointment of provisional liquidators on the basis that there is a risk of dissipation of assets by the company and that the company’s creditors need to be protected by control being removed from the board and the assets ring-fenced from creditor action through the statutory moratorium.

In each of the above scenarios, the provisional liquidation application is issued in winding up proceedings and the filings and the hearings are usually heard urgently and confidentially, in order to ensure that the protections sought are not defeated by creditors having prior notice of the application and taking urgent steps to seize company property.  Once the provisional liquidators are appointed, the statutory priorities apply: (i) unsecured creditors are free to enforce, regardless of the appointment of joint provisional liquidators; (ii) petitioning creditors’ costs are payable as a first priority, then liquidation expenses, and then general unsecured creditors.

For a creditor, the standstill agreement alternative may be a preferable pathway given that it does not shackle the creditor’s recovery to a court process and to dilution of recovery due to all creditor claims being adjudicated and the cost of the liquidation being paid from the company’s assets.  However, a creditor would not wish to use the contractual basis for standstill where there are suspicions that the board has or may be likely to engage in dishonest conduct and dispose of assets to defeat the creditor’s and other creditors’ claims.  In that scenario, the creditor would be best advised to take the path of safety and seek the appointment of joint provisional liquidators, so as to safeguard the prospect of some recovery, even if it is of a lesser amount and at a significantly later date.

STANDSTILL AGREEMENTS

With all of the challenges facing businesses as a result of the Covid-19 pandemic and its effect on the global economy, parties in creditor-debtor relationships may well wish to take a consensual approach to the unique circumstances they face.  In Guernsey, it is possible for a debtor and creditor to reach broad agreement on an arrangement between them in the form of a standstill agreement, on terms that each party can accept.  The benefits to both the creditors and the debtor company have already been well noted.

Guernsey law employs the doctrine of prescription, which is similar to the notion of limitation periods seen elsewhere.  Prescription, however, operates to completely extinguish the right to a claim, in contrast to limitation, which bars a claimant from access to a potential remedy.  There is debate as to whether a standstill agreement would be valid as a means of contracting out of statutory prescription periods, but in general parties accept standstill agreements are enforceable as a private contract.

STATUTORY MORATORIUM

The Companies (Guernsey) Law, 2008 includes a corporate rescue regime.  The law specifically provides for an administration procedure equivalent to that of the UK, although at present it can only be achieved via an application to Court (for an administration order) by the company itself, the directors, members or creditors (out of court administration appointments are not presently permitted).  In short, such an order will be made if (i) the company is insolvent or likely to become insolvent, and (ii) the administration will achieve the survival of the company as a going concern, or a more advantageous realisation of the company’s assets than would be effected on a winding up.  The administration order will trigger a moratorium with respect to claims against the company until the administration comes to an end.

Parties may enter into forbearance agreements providing for a moratorium on payments to creditors.

STANDSTILL AGREEMENTS

Isle of Man law does not impose any restrictions on standstill agreements.  In the face of a credit crunch, debtors and their creditors are free to enter into such arrangements as they may determine to be in their long term interests.

As has been noted elsewhere in this article, the benefits of a standstill agreement accrue to both parties where there is commercial sense in ‘buying time’ for the debtor company to recover.

STATUTORY MORATORIUM

Isle of Man insolvency law is governed by the Companies Act 1931 and the Winding Up Rules 1934. The statutory provisions for insolvency set out in that legislation promote the traditional insolvency law principles of winding up a “failed” company, rather than the more modern approach of rescuing that “failed” company introduced by the Insolvency Act 1986.  However, the Manx courts have shown a willingness, in circumstances where it would appear to be to the greatest benefit of all parties concerned, to reach outside Manx shores and take advantage of the more modern rescue insolvency remedies which are now well established in England and indeed other foreign jurisdictions.  One could argue that the main distinction between the insolvency regimes in the Isle of Man and England in the modern era, has been the lack of an administration process in the Isle of Man.

There are various examples in recent years of the Isle of Man Court’s evolving approach from viewing liquidation as being the only option for an insolvent Manx company to accepting appointments of provisional liquidators and indeed recognising the appointment of foreign administrators and examiners with the purpose of providing the Manx company with an opportunity to rescue itself rather than assigning it to certain liquidation (see, for example, Capita Asset Services (London) Limited’s application to the Isle of Man High Court for a Letter of Request to be issued to the High Court of England and Wales seeking that the English Court make an administration order over Gulldale Limited under the Insolvency Act 1986).

With foreign jurisdictions having developed their insolvency regimes to now arguably be more focused on rescue than liquidation, it was perhaps inevitable that the Isle of Man Court would, in the absence of statutory provision, exercise its inherent discretion to reflect such a movement, albeit only in circumstances where the rights of secured creditors are unaffected.

With the Isle of Man being an offshore business centre, most Manx companies form part of complex global corporate structures which hold assets in various jurisdictions.  It is therefore of paramount importance that should an insolvency situation arise within such a structure, the Isle of Man Court not allow the constraints of its statutory regime to prejudice the overall insolvency strategy.  Indeed, Gulldale should provide comfort that the Court will do all it can to facilitate the global insolvency strategy, even if this means requesting that insolvency procedures not recognised within the jurisdiction be applied to the Manx company.

Jersey’s domestic corporate insolvency system remains relatively undeveloped, and bears little relation to those found in other jurisdictions.  There is no administration or other formal rescue jurisdiction, nor are there statutory demands or winding up petitions. The only insolvency process which can be invoked by a creditor is désastre, a type of compulsory liquidation process under which the assets of the debtor vest in the Viscount (an executive official of the Court who acts as the island’s Official Receiver). Jersey is however, generally regarded as a creditor-friendly jurisdiction, principally because of the rights afforded to secured creditors under the Security Interests (Jersey) Law 2012.

In view of the above, there is no established practice in Jersey of standstill agreements between a creditor and a debtor, nor is there any case law on the point. However, given the very considerable weight which is afforded in Jersey to upholding contractual arrangements between parties (under the customary law maxim la convention fait la loi des parties), there does not appear to be any reason why a standstill agreement in this context should not be workable.

Similarly, the only statutory basis for a moratorium under Jersey law is the making of a declaration of désastre (or the declaration of a creditors’ winding up, which despite its name can only be instigated by the shareholders of an insolvent company). However, the Jersey Court has shown a great deal of willingness to fashion flexible solutions in order to facilitate rescue or restructuring, usually through the use of the just and equitable winding up procedure. In an appropriate case, it is conceivable that the Court would impose a moratorium under this procedure to allow negotiations or restructuring to take place.

STANDSTILL AGREEMENTS

It is generally accepted that out of court workouts allow viable businesses to continue to operate and to emerge successfully from financial distress.  They also allow creditors generally, but lenders specifically, to reduce losses and avoid the social and economic impact of major business failures.  Key stakeholders, such as customers, employees, suppliers and investors are at an advantage given that businesses subject to out of court restructuring proceedings continue to trade.

There is no doubt that out of court restructurings help to reduce pressure on courts and may prove to be more efficient and effective than court procedures due to the shorter time frames and higher recovery rates.  As such, they assist the commercial community in developing confidence in the fairness, transparency and accountability of insolvency and restructuring proceedings.  In the aftermath of the economic fallout of the Covid-19 pandemic, these considerations loom large for creditors and debtors alike.

Prior to proceeding with out of court workouts, the debtor should assess whether there is a realistic possibility that its financial difficulties can be resolved with a view to its long-term viability.  If restoring the long-term viability of the debtor is not possible, alternative remedies, such as the liquidation of the debtor by way of formal insolvency proceedings, should be considered.  The standstill period should be limited to the time that is reasonably required to produce a viable restructuring plan, or to determine that such a plan cannot be produced within an acceptable time limit.  The standstill period will vary from case to case, although usually it would not be longer than a few weeks.  During the standstill period, it is vital that the relevant creditors receive adequate reliable information so as to be able to assess the debtor’s financial position, to understand what has caused the underlying financial problems, and to evaluate any proposed solutions that are put forward.

All negotiations between the debtor and the relevant creditors should be conducted in the utmost good faith, in an atmosphere of honesty and frankness, and with the objective of finding a constructive solution to the debtor’s financial problems.  If any of the parties lose confidence that their counterparts are negotiating in good faith, the negotiations to find a constructive solution are likely to fail which will in turn lead to the relevant creditors falling back on their legal remedies of enforcement and/or the commencement of insolvency proceedings.

While a written agreement for a standstill period is not necessary in cases where an effective informal understanding amongst the relevant creditors exists, it is obviously highly preferable for certainty and evidentiary purposes.  Where there is a written standstill agreement, it is necessary for the creditors who are parties to it to agree that, during the standstill period, they will not to try to improve their positions relative to other creditors; will not insist on payment of amounts owing to them; will not initiate collection, security enforcement or liquidation proceedings; and will allow existing credit lines and facilities to be used.

The ability of the debtor to continue in business during any period of negotiation is central to the success of an out-of-court restructuring.  While some debtors may not need to depend on third party financing to continue operating, many do.  In such event, or where additional funding is required for other justifiable reasons during the restructuring process, the sources are typically the proceeds of the sale of non-core assets, new investment from shareholders, or additional lending from existing creditors (including banks).  Unless a certain degree of priority is accorded to any additional lending, it is highly unlikely that financing will be made available, and the workout may fail to survive long enough to permit a restructuring plan to be fully developed and considered by the relevant creditors.

STATUTORY MORATORIUM

The Mauritius Insolvency Act 2009 comprises a detailed and robust insolvency regime including a process for administration.  An administrator is typically appointed by the directors of the company where it appears that the company will be unable to pay its debts as they fall due.  Application for the appointment of an administrator may also be made by the secured creditors that hold valid and enforceable security over the whole or substantially the whole of the company’s property.

Upon the commencement of administration, a moratorium goes into effect, prohibiting any proceedings against the company (although creditors can still resolve to liquidate the company if the legal test for such petition is met).  The administration ends when the Court so orders, typically when the company has resumed business as a going concern or where it becomes clear that the company is no longer viable and is therefore put into liquidation.

Similarly, where a liquidator is appointed, application may be made by the company or any creditors or contributories of the company to impose a moratorium on legal proceedings until the liquidation has been completed.