New Interpretation of English Insolvency Law: Re Cheyne Finance PLC
July 8, 2008
The UK courts recently interpreted the definition of insolvency in a way which can lead to an insolvency default being triggered earlier than before.The decision in Re Cheyne Finance PLC introduced a new interpretation of English insolvency law. UK companies, including subsidiaries of US companies or those otherwise part of an international group, will need to take account of this change when negotiating insolvency events of default in credit agreements or any other contracts in which they arise (e.g., leases, shareholder and partnership agreements, joint venture agreements and commercial agreements for the supply of goods and services) and when considering disclosure obligations.
The Typical Insolvency Default: the Old Interpretation
The English courts are empowered to wind up a company which is unable to pay its debts. A company is deemed unable to pay its debts in a number of circumstances prescribed by statute, including where a creditor serves written demand for a debt then due exceeding £750 which is not paid or settled within three weeks of the demand. A company is also deemed to be unable to pay its debts if it is proved “to the satisfaction of the court” that the company is balance sheet insolvent. As a result most English law finance documents contain three insolvency events of default related to the financial status of a company:
A member of the Group is unable or admits inability to pay its debts as they fall due(known as “cashflow insolvency”), or is deemed to or declared to be unable to pay its debts under applicable law; suspends or threatens to suspend making payments on any of its debts; or, by reason of actual or anticipated financial difficulties, commences negotiations with one or more of its creditors with a view to rescheduling any of its indebtedness. - The value of the assets of any member of the Group is less than its liabilities (taking into account contingent and prospective liabilities). This is known as “balance sheet insolvency”.
- A moratorium is declared in respect of any indebtedness of any member of the Group. If a moratorium occurs, the ending of the moratorium will not remedy any Event of Default caused by that moratorium.
English law finance documents also contain defaults covering insolvency procedures and then typically go on to provide that any similar insolvency status or procedure under any other relevant jurisdiction is also an event of default. This is also common in New York law credit agreements. The change in the English law interpretation of insolvency will therefore also affect US companies with UK subsidiaries where the US parent enters a New York law credit agreement with a provision covering comparable insolvency status or procedures which is applicable to group members in the United Kingdom.
Re Cheyne Finance PLC
The case of Re Cheyne Finance PLC involved a UK-based investment company which went into an insolvency procedure (administrative receivership). The court considered the precise meaning of insolvency. Under English insolvency legislation a company is considered to be insolvent if it is unable to pay its debts as they fall due. This phrase is often incorporated into credit agreements and, as noted above, is sometimes known as cashflow insolvency.
Before the decision in Re Cheyne Finance PLC the standard adopted by the courts in deciding whether or not a company could pay its debts as they fall due was simple: has a sum which is due been unpaid? If an overdue amount was unpaid the company was insolvent, as it was proven to be unable to pay its debts as they fell due. Parties negotiating loan facilities and other agreements understandably approached the question of insolvency in a similar way, though agreements might be modified to exclude frivolous winding-up petitions which are quickly rejected or to cater for specific needs (for example, excluding the balance sheet insolvency test).
Insolvency: the New Meaning
In Re Cheyne Finance PLC the court decided that the phrase “unable to pay its debts as they fall due” means that the court should look at whether a borrower is paying current debts and whether it will be able to pay future debts. The court decided that, if a borrower is unable to pay debts falling due in the future, this can mean the borrower is insolvent in the same way as if it is unable to pay its current debts, even if the company is paying current debts.
Significance of the Change
Including the inability to pay specified future debts when determining cashflow insolvency means creditors may well be in a position to call an event of default sooner than was previously thought to be the case: the creditors do not need to wait for the non-payment actually to occur. This is particularly likely to happen if a company is financially distressed and a substantial scheduled principal payment is falling due within the next quarter or so. In short, there is a more sensitive event of default trigger than anticipated.
When an insolvency default is triggered, creditors are generally entitled to refuse to make any future advances and to accelerate repayment of all amounts owing by the borrower to the creditor. Any cross guarantee will also be triggered, and so all guarantors’ contingent liabilities may be crystallised.
The effect of triggering an event of default can be magnified if there are cross-default provisions which allow other creditors (for example creditors of a parent company) to call a default under their credit agreements as soon as an event of default or a right to accelerate amounts owing arises under another credit agreement. The greater sensitivity of UK events of default in a financing agreement could therefore have a knock-on effect throughout an international group. Triggering a UK event of default could mean triggering the right for all lenders to accelerate all borrowing obligations in the group so that all debts become due.
Actions Corporate Borrowers Should Take
Corporate borrowers might want to review existing financing arrangements with a focus on insolvency and cross-default provisions to see if the insolvency events of default exclude future debts. Avoiding the possible cross-default will be important to all companies. Listed companies will also want to consider their disclosure obligations and may need to negotiate an early amendment to their credit facilities to avoid the need to make a disclosure.
