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If another business owes your business money which is overdue, it may be insolvent or close to insolvency. You may, therefore, have received notice from your debtor that it has obtained a moratorium from an English court. A pre-insolvency moratorium means that you cannot pursue your debtor in court for their debt to you. For instance, you may supply a client with £100,000 of professional services, which the client cannot repay. Alternatively, these may be £100,000 worth of goods. This article will explain in detail how pre-insolvency moratoria operate and their practical effect on you as a creditor.
Pre-Insolvency Moratorium
In general, a moratorium is a court order forbidding any party, such as your business, from bringing any claim against another business, such as your debtor, for a specific period. A pre-insolvency moratorium can only apply to limited companies and LLPs, so not possible for sole traders, general partnerships, or private individuals.
When a moratorium is in place, you cannot petition the court to initiate proceedings against the company as one of the company’s creditors. If there is no moratorium in place, you can commence proceedings against the company. If your case is strong, the court may make an order in your favour.
Purpose of a Pre-Insolvency Moratorium
Clearly, moratoria are not in your favour as a creditor. However, they are in place for a good reason, as when a company is facing financial difficulty, the law prefers for the company to work together with its creditors towards a solution.
This encourages you to work together with any other creditors so that you all can receive some of your debt back. Otherwise, they may organise without you, negotiate with the debtor and arrive at a solution, not in your interest.
Moratoria also saves the court time and resources by avoiding separate claims by the company’s creditors.
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Effects of a Pre-Insolvency Moratorium
If your debtor obtains a moratorium, you cannot file any claim against them for 20 days. The debtor’s directors can extend the moratorium period for another 20 days and a further 40 if they obtain the consent of a majority of the creditors by value or by court order. Therefore, you may be unable to file a claim for up to 80 days.
Additionally, you cannot:
- enforce any security interest you have over the company’s property, including crystallising a floating charge into a fixed charge;
- launch a debt claim for any secured or unsecured debt in court;
- try and initiate liquidation or administration proceedings;
- crystalise a floating charge into a fixed charge; or
- forfeit the debtor’s lease if your business is its landlord.
The Monitor
As part of the debtor’s application to the court, it has to nominate a monitor. A monitor is a court officer and licensed insolvency practitioner, so independent from the company. Its role is to observe the conduct of the company and its directors to ensure they are acting within the law and that the business has a reasonable chance of being rescued.
If you believe the monitor is behaving unlawfully, you can apply to the court to have the monitor’s appointment or position challenged. Likewise, it is best to do this with the other creditors.
Restructuring
A moratorium gives a company’s directors breathing room to arrange its affairs, allowing it to agree with its creditors, including you. This is a consensually agreed restructuring.
Restructuring refers to any arrangement or transaction between the debtor and its creditors that modify the terms of any pre-existing debt. Restructuring can be varied, as demonstrated in the examples that follow. For these examples, imagine your creditor is a manufacturing company called Hard Times Co. It owes money to the following creditors:
- £250,000 in the form of a secured bank loan to Big Bank Ltd;
- £100,000 in unsecured debt from a group of debt investors; and
- £100,000 to three trade suppliers, including your business, which is owed £50,000.
An Example
| Refinancing |
In exchange, Big Bank Ltd charges Hard Times Co 5% more in interest. |
| Debt for equity swap |
|
| Distressed sale | Hard Times Co finds a third-party investment fund willing to purchase the company at a steep discount on the condition that the fund injects £400,000 into the company. £250,000 of this new money goes to the secured bank lender. £100,000 goes to the trade suppliers, including your business. The unsecured lenders lose £50,000 of their debt in exchange for obtaining a 25% stake in the business. |
Practical Considerations
The above example illustrates how parties can restructure in different ways. The extent to which any creditor benefits from a restructuring depends mainly on what kind of creditor they are. As a general rule, secured creditors receive the largest portion of their debt back because they have security rights in the company. During negotiations, they can refuse to budge unless paid back in full. Once the moratorium expires, they can enforce their security over the debtor’s assets.
Unsecured creditors like your business are in a less favourable position. This is because, in the event of a liquidation, you will be paid after the secured creditors and often after the unsecured lenders. Of course, if there are many trade creditors with a considerable aggregate value of debt, you can band together and use this value to negotiate with other creditors.
Key Takeaways
Pre-insolvency moratoria can help distressed companies to achieve a consensual restructuring with their creditors. As a creditor, if your debtor obtains a moratorium, you cannot try and enforce your claim against them in court until the moratorium expires, which can take as long as 80 days. This gives the company’s directors breathing room to work with their creditors, including you, towards a consensual solution. As a creditor, it is usually in your interest to work with the other creditors and the debtor towards a solution. The extent to which you may benefit from any solution depends on your strength as a creditor.
If you need help with pre-insolvency moratoriums, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today at 0808 196 8584 or visit our membership page.
Frequently Asked Questions
A pre-insolvency moratorium is an order granted by the court upon application by a distressed company. The order prevents any creditor from bringing a claim against the company, giving it room to negotiate with them and arrive at a consensual restructuring.
Only limited companies and LLPs can apply for a moratorium. So if your debtor is a sole trader, a general partnership, or a private individual, they cannot obtain one.
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