Whether as a result of the influence of social media and in particular the speed at which information (as well as misinformation) travels, most governments’ communication efforts in keeping citizens informed during the coronavirus crisis (in many cases involving daily briefings) has been impressive. At the same time, almost not a day has gone past without a mention in the online media of some threat of insolvency involving entire industries, including some of the biggest corporate names. People should therefore at least now have a real sense for how serious the economic (and not just social) impact of the current crisis could be. A number of governments (including Spain, Germany, U.K., Belgium, Australia, India, New Zealand, among others) have already announced amendments to their insolvency legislation in response. These are generally part of a wider package of measures and financial relief implemented by governments designed to mitigate damage to the economy. Without these unprecedented interventions it is difficult to see how our way of life could survive.
Why are governments around the world doing this?
Policymakers around the world are now acutely aware that the damage to their economies is not just from a period of prolonged lockdown (few businesses could have withstood even a period of 4 weeks total economic standstill absent government support schemes of the type we have seen being implemented) but from the recession that is coming (or is already here) as a result of the current economic crisis. It is like being hit by the tsunami (lockdown) and then the secondary waves that will hit businesses over a prolonged period of time (recession). We saw this too after the 2008 global financial crisis. But unlike any previous crisis, this one affects the entire economy - manufacturing, services and leisure, the supply chain, the financial markets, consumer spending, business to business relationships and credit.
For context, it is forecasted that the global recession the current lockdown and economic crisis will unfold will be the worst in 100 years. Britain itself is said to be facing the worst recession in 300 years. The estimated 59 million jobs at risk in Europe alone is staggering, let alone the very many businesses (large and small) that are already, or will become, insolvent as a result of all this. In the United States, according to latest published figures, there are already 33 million people unemployed since the pandemic.
Typically, domestic legislation will have two tests of insolvency: cash flow insolvency and balance sheet insolvency. Some businesses may face the prospect of cash flow insolvency if revenues collapse and no funding is available. Others could face balance sheet insolvency if liabilities exceed assets but the most likely scenario for a business is cash flow insolvency, if not because the company has failed to meet its payment obligations, then in anticipation of reaching that position at a future point in time. The latter would usually be days or weeks (maybe months in specific circumstances).
Hence the need for some form of statutory insolvency protection during the pandemic period and post-recovery. Otherwise, understandably, directors will jump to put otherwise viable businesses into a formal insolvency process, if creditors themselves don’t do it first, or they enforce payment against it, thereby worsening the financial position of the company. Once a business enters into a formal insolvency process in the current economic situation (even in administration), in all probability it will no longer be saved and jobs will be lost, whereas outside a insolvency process the business might recover.
What is Gibraltar proposing?
Against this background, the Gibraltar Government has published a Bill of its own temporary insolvency related measures, following detailed consultation, to protect businesses, jobs and the wider economy.
The measures, by way of amendment to the Insolvency Act 2011 (inserting a new Part 21), are primarily intended to allow directors of otherwise viable businesses to carry on trading even if there are insolvency concerns arising from the pandemic (for example, paying staff and suppliers) without the risk of personal liability. It is important to emphasise, however, that whether or not a business can ultimately survive will be dependent on the directors’ ability to raise finance or restore its financial position. If the company has no financial means to continue trading even whilst insolvent, it is unlikely these measures on their own will help.
The key measures are suspending the right for creditors to issue a statutory demand of an eligible business to avoid it being placed into liquidation as a result of the economic crisis caused by the coronavirus, introducing a moratorium, as well as disapplying personal liability for directors under the Gibraltar equivalent of U.K. ‘wrongful trading’. There are several mechanisms that ensure that the regime will not be abused or even used for unintended purposes. For example, only businesses that are licensed or authorised in Gibraltar can avail themselves of the new insolvency protection. This would obviously include Gibraltar financial services and gaming companies. Creditors will therefore be unable to frustrate funding and continuation of trading by eligible companies through the taking of individual creditor actions (ie issuing a statutory demand and presenting a winding-up application).
The regime is extended to non-corporate entities to the extent that they are within the scope of the legislative provisions. The legislation would allow businesses to make payment to creditors in the ordinary course if they are able to make such payments and it is advisable for businesses in financial difficulty to engage with their creditors to structure payments realistically through their cash-flow difficulties. Suspending the usual insolvency provisions to allow companies to continue trading in the particular circumstances of the present crisis would also be in the creditors’ interests to the extent that a company can be saved rather than forced into liquidation/administration.
Nor does the legislation prevent companies themselves commencing liquidation if they consider that the business cannot be saved during or even after the crisis, notwithstanding the statutory protection that would otherwise be afforded if they didn’t.
Owners that can support their business with injections of capital or by not drawing from the business or even by receiving reduced remuneration, to provide much needed liquidity, should consider doing so. Whilst this might not necessarily restore the company’s solvency, it could avoid the business running out of cash during the period of lockdown or downtown (or even complete halt) in economic activity and therefore ensure that the business can survive.
Even before the announcement of these legislative changes, it has not been law in Gibraltar that a company could not trade whilst insolvent but the consequences for the directors if they did was personal and criminal liability and as a result directors would have unlikely taken such risk. What the new temporary regime will do is remove (or suspend) this to allow directors to navigate the extremely complex and challenging period we face, saving jobs and allowing continued economic activity, rather than the value and wealth destruction as well as job losses that arises from a liquidation/bankruptcy. This could include the incurrence of new liabilities notwithstanding insolvency since the risk of personal liability attaching to directors is suspended provided the business and actions of the directors are within the scope of the temporary regime. As stated, abusive action by directors would not be protected.
The protection afforded under the new regime is akin to an ‘administration’ without a formal insolvency process (but not preventing legal access to the courts) to allow eligible companies to continue to trade through its board of directors/management whilst ‘insolvent’ without the directors incurring personal liability. This could protect large local trading companies with hundreds of employees (for example, allowing directors to pay salaries) as well as smaller retail or restaurant businesses. In particular, the larger local companies that are licensed or authorised in Gibraltar would want such protection as otherwise directors will not take chances and instead would act to place companies into a formal insolvency process. After the first few companies in financial difficulty had petitioned for liquidation, there would have been enormous pressure on other companies to do likewise and this would have become as contagious within the business economy as the Coronavirus itself. The negative economic impact of liquidations across the economy would then be significant and irreversible. The Gibraltar Government has therefore acted resolutely to try to prevent this from happening.
The new measures will therefore provide much needed breathing space to try to weather the economic storm. Companies in financial difficulty should, in the light of the proposed amendments to the insolvency laws, take professional advice when implemented and devise a plan for the turnaround of the business (including where appropriate a restructure) to attempt to avoid liquidation in the future.
What can businesses also do to help themselves?
Of course, one cannot look at the temporary insolvency measures being introduced by countries around the world in isolation from other actions companies and their shareholders should be considering, including injection of shareholder capital (directly or indirectly) to support cash-flow/paying debts, bringing in new investors, negotiating with creditors (for example, landlords in respect of rent or bank lenders) and cutting non-essential spending. Realistically, few businesses will see the same trading conditions or revenues as before the coronavirus and they must now instead adjust to the continuation of social distancing restrictions for some time as well as changing consumer/supplier/client behaviour. This may necessarily include engaging with creditors and other stakeholders (such as employees) to avoid simply deferring a liquidation into the future.
Indeed, unless shareholders (whose financial support will most likely be required) and the board of directors of the companies (who must now expend considerable energy over the next months, perhaps even years, to keep their workers employed and businesses going), are persuaded that the business can survive (and for this to happen employees themselves could also reasonably be expected to support companies through this economic crisis), liquidation may become inevitable. In most cases, common-sense should prevail to achieve a shared objective of trying to save the business and jobs during this unprecedented crisis.
The biggest challenge I think will come in the third quarter of the year (July, August, September) when governments wean off businesses from subsidies and job retention schemes and if cash flows do not recover. In these circumstances, businesses should be looking to manage their revenues more evenly over the next 6 months (rather than in a shorter time that results in an upside down ‘V’) to ensure cash is available over the period to meet commitments.
A New Normal or New Dawn?
If not a ‘new normal’ then a ‘new dawn’ is emerging from the coronavirus, one where the rule book is thrown out of the window and companies must look for new business models to survive the aftermath of the pandemic. International tourism (travel and hospitality) will be particularly hit and national economies must find new ways of keeping the sector afloat (for example, by encouraging domestic tourism or promoting ‘virtual’ tourism). Of course, whether tourism in every form will ever return to ‘normality’ is itself debatable. Restaurants, in turn, will have to maintain social distancing measures for some time when they are allowed to reopen. Neither might be profitable during the economic crisis but at least may be able to cover their expenses. In a weak economy (especially during the lockdown) professional firms (law, accounting, consulting) that are dependent on clients who themselves are hurting will be face difficulty, especially with commercial, financial services, property and court work all affected at the same time. But with technological home working now firmly established, the era of ‘Big Accounting’ and ‘Big Law’ with their expensive office space could be coming to an end. So too must global regulators embrace ‘virtual’ offices, not just as a new means of working, but as a way to manage business costs in the future. Of course, one of the biggest challenges (and this is true in any recession) will be how to encourage consumer spending (for example, in the retail sector) when people are concerned about job security. There are no easy answers unfortunately but we may have to innovate.
I have been professionally involved in advising large businesses on restructuring and insolvency over a number of years. One of the biggest mistakes for companies in the current crisis, in my view, would be to be overly optimistic about future trading prospects and the return to ‘normal’. This is because the economic outlook is highly uncertain and all major economies in the future will face recession, so whatever the ‘new normal’ looks like it will certainly not be the same as we knew it before. If business owners can adapt to this change in mindset, there are, however, potential opportunities for those who find ways of doing things differently from everyone else. Indeed, who thought 40 years ago that buying insurance, placing a bet or shopping from the comfort of your own home (by telephone or using computers) would take off and grow as fast as it has?
Over the years, I have also seen distressed businesses being turned around to become phenomenally successful in their chosen markets. Typically, an outside investor challenging conventional thinking made all the difference. In another case of a distressed financial institution (which could serve as an example for businesses in the current crisis), a new director with restructuring skills joined the board knowing the company was insolvent to help continued trading during insolvency for the benefit of creditors, and retired after the eventual planned administration (all whilst communicating with and keeping stakeholders fully informed), thereby helping to minimise losses for creditors.
Whilst no consolation to the businesses that might still unfortunately fail over the coming months, if not years, because of the coronavirus, I am pleased to see a move by governments worldwide to de-stigmatise insolvency. As I pointed out in an article I published in March 2016 entitled “Is There A Case For A More Balanced Approach To Insolvency And Directors/Managers Liability?”:
“To stigmatise insolvency is to ignore the fact that capitalism is about risk-taking and that businesses can fail for reasons other than wrong-doing. Unfortunately, however, insolvency can sometimes be the start of the blame-game. Allegations following an insolvency can also have the potential to sully people's well-earned reputations and dampen entrepreneurial flair.”
In the ‘new normal’ (if not ‘new dawn’) the stigma attaching to directors of failed companies should therefore reduce significantly but perhaps it shouldn’t have taken this economic crisis for this realisation to dawn.
Nigel Feetham QC has appeared before the Supreme Court in three administration applications on behalf of the applicant company over the last 18 months, most recently for Quick-Sure. Nigel’s work at his law firm Hassans has been recognised in numerous prestigious industry awards. He is also the author and co-author of several books including “Protected Cell Companies: a Guide to their Implementation and Use” which was in May 2015 cited in Pac Re 5-AT v. AmTrust N.A., Inc., No. CV-14-131-BLG-CSO, 2015 a decision of the Federal Court of Montana (USA). The views expressed in this article are solely the author’s own.