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Restrictions of creditor rights during Covid-19

On 25 June 2020, the Corporate Insolvency and Governance Act 2020 ('the Act') received Royal Assent and is now enforceable law.  The Act contains a number of measures relating to both insolvency proceedings and corporate governance, and for the most part intends to provide companies and their directors with greater protection and flexibility during covid-19 and therefore restricting creditors from pursuing debt (even pre-covid debt).

Scope of the Act

The Act:

  • Provides new, comparatively debtor-friendly, provisions to assist in rescuing financially distressed companies. These comprise of:-
    • A new statutory moratorium process;
    • A new restructuring plan procedure; and
    • Provisions invalidating contractual provisions in contracts for the supply of goods and services, triggered by insolvency proceedings.
  • Provides relief for directors and their companies from creditor action on debts due to covid-19. They comprise of:-
    • Provisions mitigating director liability for wrongful trading during the pandemic; and
    • Provisions restricting the presentation of winding-up petitions for a four-month period to recover debt.

Below we focus on the three areas that we believe will have to biggest impact and delay on creditors ability to recover debts.

New statutory moratorium process (Section 3/Schedule 4)

A moratorium is a process which leaves the directors to trade the company with an insolvency practitioner acting in the role of “monitor” overseeing the company’s affairs. The aim is to afford companies some breathing space from creditor action to formulate a turnaround plan. The moratorium is focused on the recovery of the company rather than the realisation of its assets.

The moratorium provides 20 business days protection from certain creditor action. It can be extended for a further 20 business days without any consent, or for longer with consent. The monitor must be, and remain, of the view that a rescue of the company will be possible. If the monitor is no longer of that view, the moratorium must end.

During the moratorium, the company must continue to pay certain debts including newly incurred liabilities, payments for new supplies, rent, certain payments due to employees, and debts under financial contracts, including lending contracts. If those debts are not paid, the moratorium will end. If these debts are not paid, they will be given priority in an insolvency occurring within 12 weeks of the end of the moratorium.

During the period from the day the Act came into force (26 June) to 30 September 2020 there are some changes to the usual eligibility criteria for moratorium. The main changes are:

  • The requirement that the monitor is of the view that it is likely a moratorium would result in the rescue of the company as a going concern is relaxed slightly so that the monitor must only be of the view that a rescue would be possible were it not for any worsening of the financial position of the company for reasons relating to covid-19; and
  • A company will be eligible for a moratorium even if it was subject to a prior moratorium or administration in the previous 12 months.

Mitigation to directors for wrongful trading (Section 12)

The provisions do not seek to amend the already existing wrongful trading provisions in the Insolvency Act 1986, but they sit in parallel to them.  They concern the period beginning 1 March 2020 to 30 September 2020 (the “Relevant Period”), but this period can be extended up to six months which is ultimately dependent upon the climate’s improvement.

In short, the provisions largely suspend the potential for wrongful trading liability to be incurred during the Relevant Period. There is a blanket requirement on courts to assume that a director is not responsible for any worsening of the financial position of the company or its creditors during the relevant period. There is also no requirement to show that the deterioration of the company’s financial position was due to covid-19. This is good news for directors, although the insolvency industry has raised concerns that this could possibly result in director abuse and injustice to creditors during the relevant period as a result.

Statutory Demands and Winding Up Petitions (Section 10/Schedule 10)

The Act also imposes restrictions that prevent winding-up petitions from being presented to court on or after 27 April 2020 where they rely on a preceding statutory demand served during the relevant period (1 March 2020 to 30 September 2020).

The only exception to issuing a statutory demand and winding up petition (where it is still considered valid) is if you have reasonable grounds for believing covid-19 has not had a financial effect on the company or the debt issues would have arisen anyway. Whilst in some circumstances it may be very obvious that a debt in question is a pre-covid debt in that it became due and payable prior to 2019, the courts are making it very difficult and costly at the moment for creditors to purse debts against debtors in attempt to deter them from doing so at this time.

If you were to rely upon the presumption of insolvency due to a debtor’s failure to satisfy a statutory demand served between the aforementioned time frame and subsequently filed a winding up petition, there would be a requirement to also file further supporting material detailing why covid has not had a financial effect on the company or the debt issues would have arisen anyway which will be very burdensome to undertake as even though the debts are pre-covid, covid may still be having a financial effect on the company as of now to pay the debt demanded which will be difficult to convince the court of (in the absence of financials from the debtor company which would usually not be in the possession of most creditors). We should also note that courts will certainly be favouring the debtors if in doubt.

Where the court disagrees with a petitioning creditor's assessment that covid has not had a financial effect on the company, the court still has discretion to make a winding-up order if it is satisfied that the company's inability to pay its debts would have arisen anyway. This provision applies from 27 April 2020.

Given that most creditors want to be commercial in attempting to recovering debt, we recommend to creditors to wait until after the relevant period to serve a statutory demand. If a statutory demand is served within this backdated period, it will be void and likely won’t have the usual effect in that a solvent debtor companies usually would take it seriously given the consequences that can follow from it (i.e. avenue to present a winding up petition) as most debtors will be using these proposed temporary measures to their advantage.

What this means?

The above protections are only supposed to combat “short-term” liquidity in the current climate. Where there is evidently no realistic prospect of a company avoiding insolvency, the court will not prevent or delay a creditor from recovering the debt. It will just be a more burdensome in that further material will have to be filed to convince the court of the above.

Further, the Government considered that this new law was essential as lockdown guidelines ease and the economy is kick-started as businesses will need some time to get back up to speed and reconfigure following the effects of months of limited trading.


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Legal Disclaimer

Articles are intended as an introduction to the topic and do not constitute legal advice.