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A pre-insolvency moratorium is an available tool for companies facing insolvency. Insolvent companies with a viable prospect of turning their business around can use a pre-insolvency moratorium to reach an arrangement with their creditors to restructure their debts. This article will explain the effect of a pre-insolvency moratorium and how your business can use it to its advantage.
What is a Pre-Insolvency Moratorium?
A moratorium is a court order forbidding any party from bringing legal action against an individual for a certain period of time, called the moratorium period. In the context of insolvent companies, either the company itself or its creditors can bring a moratorium.
The purpose of a moratorium is to freeze the ability of a company’s creditors to petition the court to initiate proceedings against the company. Absent a moratorium, the court might allow as many creditor actions against the company to proceed as there are creditors. This wastes court resources and prevents the insolvent company from reaching an agreement with its creditors that might maximise all parties’ interests.
Pre-insolvency moratoriums are a specific kind of moratorium available to companies whose directors fear the company may imminently become insolvent. To avoid insolvency, the directors intend to arrange a consensual debt restructuring with their creditors. This is where the company borrows more money to pay off old debt.
What is Insolvency?
Insolvency refers to a company that cannot pay debts exceeding £750 within three weeks of a creditor serving notice. Alternatively, a creditor with a debt claim against your company can file its creditor action with the court, at which point the court will rule whether the company is insolvent.
Purpose of a Pre-Insolvency Moratorium
The general purpose of a pre-insolvency moratorium is to give a company’s directors breathing room to control the company’s affairs and work towards a consensual solution with its creditors.
The extent of solutions available to your company depends on its circumstances and the willingness of creditors to negotiate. If there is a chance the company can turn itself around, directors may try and negotiate a debt refinancing. Debt financing is where the company’s management stays the same, and current shareholders maintain some degree of control over the company.
On the other hand, the company’s position may be so weak that its creditors will only entertain a transfer of ownership. In this option, the creditors convert their debt in the company to shares, which wipes out the existing shareholders. Alternatively, your creditors may engage a third-party buyer to acquire shares and inject cash into the business. In these transactions, the company will likely have new owners and management, meaning you will lose any interest in the business.
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Applying for a Moratorium
Provided the company directors are all in agreement, you must file certain paperwork with the court. Nearly all companies not already involved in formal insolvency proceedings are eligible to apply. Likewise, the moratorium will go into effect automatically once the court receives the application.
Terms of a Pre-Insolvency Moratorium
If a court grants your company’s request for a pre-insolvency moratorium, none of its creditors can launch claims against your company for 20 business days. As a director, you can opt to extend this for a further 20 days. Additionally, with the consent of a sufficient portion of your company’s creditors or a court order, your company can extend it for a further 40 days.
To extend it an additional 40 days, a majority of your secured and unsecured creditors in value must agree. For instance, suppose your company owes the following amounts to the following three creditors:
| Secured Bank Ltd (revolving credit facility) | £100,000 |
| Unsecured Building Society plc (overdraft) | £80,000 |
| Trade Supplier Ltd (wholesale goods) | £30,000 |
To obtain sufficient approval, you would need to gain the approval of at least Secured Bank Ltd and Trade Supplier Ltd because the total value of the debt is £210,000.
In theory, a court can override creditors. However, a court is unlikely to grant an additional extension without the consent of a majority of creditors. An exception is if certain creditors are acting unreasonably.
Effects of a Pre-Insolvency Moratorium
While the moratorium is in effect, a creditor cannot take action against your company. In other words, their rights as a creditor are suspended (unless the court permits otherwise). Specifically:
- a secured creditor cannot enforce its security interest;
- unsecured creditors cannot initial debt claims against your company;
- no creditor can submit liquidation proceedings against your company;
- your company’s landlord cannot forfeit its leases; and
- a creditor cannot start administration proceedings or crystalise a floating charge by turning it into a fixed charge, thereby preventing your company from using it.
The Monitor
As part of your application, you will have to nominate a monitor – a licensed insolvency practitioner. The monitor’s job is to observe the company and independently affirm to the court that the company’s business has a reasonable chance of turning around.
The monitor is an officer of the court. Under a moratorium, the company’s directors remain in control of the company, though the monitor has the power to inspect the company’s affairs.
Your company’s creditors can challenge the legitimacy of the monitor in court if they wish.
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Key Takeaways
Pre-insolvency moratoria are new tools financially distressed companies can use to achieve a consensual restructuring with their creditors. Most companies not involved in formal insolvency proceedings are eligible to apply to the court by submitting certain documents. If your application is approved, the moratorium takes immediate effect and lasts between 20 and 80 business days. When the moratorium is in place, your company’s creditors cannot enforce any debt or security claim against your company. This gives your company’s directors time to work with the creditors towards a consensual solution.
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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 time to negotiate with creditors and arrive at a consensual restructuring.
Nearly all companies facing financial difficulties are eligible, with the exception being companies that are already subject to existing insolvency proceedings. Even then, these companies are not prevented from applying, but the court may not approve the application for various reasons.
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