Rescue Moratoriums: secured creditors and a new dawn for financial collateral arrangements?

The long awaited Corporate Insolvency and Governance Bill (the "Bill") clearly swings the pendulum of the insolvency regime from being one which is creditor friendly to one which favours the debtor company by introducing (among other measures) a stand-alone moratorium, designed to provide breathing space for 'eligible companies' where it is considered that such a moratorium is, or is likely, to result in the rescue of the company as a going concern.

Assuming a company passes the 'eligibility' test, the process of obtaining a moratorium is simple enough, resulting in a payment holiday from certain pre-moratorium debts, and protection from most enforcement or other detrimental action by creditors.

The moratorium comes into force, in most cases, on the filing of relevant documents with the court or, in limited cases, upon the granting of an order by the court (for example, in the case of an overseas company). At this time, the following restrictions affecting creditors and protecting the company automatically come into place:

• no payment or enforcement of "pre-moratorium debts" and "moratorium debts" (with limited exceptions);
• no winding up petition may be presented or winding up order made;
• no administration may be commenced;
• no landlord may exercise rights of forfeiture;
• no steps may be taken to enforce any security over property*;
• no steps may be taken to repossess goods under hire-purchase;
• no proceedings or legal process may be commenced or continued.

*with the exception of taking steps to enforce security created or otherwise arising under a financial collateral arrangement (as defined in the Financial Collateral Arrangements (No. 2) Regulations 2003 (S.I. 2003/3226) (the "Regulations")).

The benefit of a moratorium to the company is clear and significant as a protective measure. But how does this impact the secured creditor, and what might be the possible unforeseen consequences on the future of lending as we know it?

For the floating charge holder, the goal posts have well and truly shifted in favour of the debtor remaining in possession during the moratorium. The existing primary right of a Qualifying Floating Charge Holder, to receive notice in advance of an administrator appointment, or to trump the administrators selected by the company by their own appointment of an administrator, is restricted for the duration of the moratorium. Not only that, but a floating charge holder cannot give any notice which would have the effect of crystallizing the floating charge (and any contractual provision or attempt to the contrary is automatically void); so effectively the company can continue to deal with the assets subject to the floating charge in the normal way, while having clearly admitted that it is in some form of financial difficulty by the entry into of a moratorium "to rescue the company…". Per the current drafting of the legislation, this applies both to new security entered into after the Bill becomes effective and to existing security arrangements.

While there are certain restrictions on the disposal of property generally subject to security, the breach of which is an offence by the company and the directors, the contravention of that provision does not itself make the transaction void or unenforceable, nor does it affect the validity of any other thing.

For the secured creditor more generally, only where new money is required from the company could they be in a slightly more favourable position. The Bill proposes that new security may be granted by a company during the moratorium, in circumstances where the monitor consents. This is likely to be the case where a creditor grants new money to fund the company during a moratorium, but the attractiveness of this proposition is short lived - the current drafting does not give any creditor willing to continue funding a company in distress super-priority (unless the moratorium is defeated and the company subsequently goes into administration, in which case super-priority is granted, with the consequence of diminishing the rights of, and return to, the floating charge holder). Where new security is being offered, the assets available as security may be, by this stage, somewhat limited or already secured. The benefit of these provisions seem to be limited to situations where there is only one (main) creditor, with no inter-creditor arrangements in place, and assume that that same creditor is willing to provide new monies.

On the face of it, it seems that the moratorium severely restricts the rights that secured creditors have previously been used to, posing obvious questions as to what this may mean to the pricing and availability of lending for companies actually seeking a rescue in the first place. It seems almost inconceivable that a moratorium can be an effective tool for a company rescue absent a supportive secured lender.

But the moratorium is also an opportunity for secured creditors to adapt and be flexible, utilising weaponry that has been, and remains, available to protect their lending position should that become necessary leverage.

As noted above, enforcement of security arising under a financial collateral arrangement is not restricted by the moratorium. This would allow a secured creditor to simply appropriate assets which fall within these arrangements without having to account to the monitor, preferential creditors or unsecured creditors or obtain a court order. Financial collateral includes cash, shares, bonds, securities and credit claims.

In most cases, the wide ambit of the Regulations means that at least some of the assets secured pursuant to all assets security will likely fall within the Regulations (assuming security over these assets has been properly perfected)¹ and thus gives creditors the rights to (arguably more quickly and cheaply) take, in the case of shares, the operating company for itself without the need for an insolvency process at all.

In addition to the ability to enforce where a moratorium is in place, there are a number of other advantages for a lender if the Regulations apply, resulting in the holder of security over financial collateral being in a better position than a holder of security over other types of asset, including:

• removing some restrictions around enforcing security;
• disapplying certain insolvency provisions relating to the order of payment; and
• preventing avoidance by a liquidator or administrator of the financial collateral arrangement.

While there are formalities which need to be followed, and hurdles to jump to ensure proper valuation of the financial collateral has been carried out in accordance with the terms of the arrangements, it seems logical that going forward lenders will look more closely at what valuation methodologies are set out in security for the shares and other securities to ensure that the Regulations are more readily available for use in respect of appropriate assets. In practice, the Regulations have previously been used primarily in respect of cash deposits, but, assuming the Bill passes into law, we would expect to see these Regulations more widely utilised as secured creditors seek to increase the options open to them in times of uncertainty.

Will the Corporate Insolvency and Governance Bill give financial collateral arrangements their time in the spotlight? We think so.

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The views expressed herein are solely the views of the authors and do not represent the views of Brown Rudnick LLP, those parties represented by the authors, or those parties represented by Brown Rudnick LLP. Specific legal advice depends on the facts of each situation and may vary from situation to situation. Information contained in this article is not intended to constitute legal advice by the authors or the lawyers at Brown Rudnick LLP, and it does not establish a lawyer-client relationship.

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¹ Under the Regulations, secured financial collateral must be delivered, transferred, held, registered or otherwise designated so as to be in the possession or under the control of the collateral-taker. There is legal uncertainty around the meaning of "in the possession or under the control of…" and various cases sought to clarify the issue. Gray and others v G-T-P Group Ltd: Re F2G Realisations Ltd (in liquidation) [2010] EWHC 1772 (Ch) held that a charge characterised as a floating charge over financial collateral will only qualify as a floating charge under the Regulations if "legal control" as opposed to "administrative control" of the underlying financial collateral is transferred to the collateral-taker. Re Lehman Brothers International (Europe) (in administration) [2012] EWHC 2997 (Ch) held that the fact that the collateral-taker is actually holding the collateral is not, of itself, enough. The critical requirement for collateral to be "in the possession or under the control of the collateral-taker" was for the control exercised by the collateral-taker to be sufficiently extensive for the collateral-provider to be properly described as having been dispossessed of the collateral.