Restructuring and insolvency law in Scotland

1. What is the primary legislation governing amicable restructuring proceedings in your jurisdiction?

The primary legislation governing consensual restructuring is:

• The Insolvency Act 1986 (as augmented by the Insolvency (Scotland) (Receivership and Winding up) Rules 2018 and the Insolvency (Scotland) (Company Voluntary Arrangements and Administration) Rules 2018); and
• The Companies Act 2006. 

2. How are amicable restructuring proceedings initiated?

Company voluntary arrangements can only be initiated by the debtor. Restructuring plans and schemes of arrangement are usually commenced by the debtor but may also be commenced by a creditor or any member.  If the relevant company is in administration or liquidation, either the liquidator or administrator can propose any of the three restructuring processes.

3. Which different types of amicable restructuring proceedings exist and what are their characteristics?

There are three main such proceedings, which are usually debtor in possession processes where existing directors continue to operate the debtor entity as restructured.

• Scheme of arrangement (Part 26 Companies Act 2006) -  this is not a dedicated insolvency restructuring tool (although can be used by companies in financial difficulties) and is available for solvent and insolvent companies alike. A scheme is a formal arrangement between the debtor and its creditors (and/or its members) or any class of them which when approved by creditors and members (as relevant) and sanctioned by the court, becomes binding. Creditors are grouped into classes whose rights are similar enough to allow them to consult together meaningfully on their common interests. To be approved each class must approve the scheme by a simple majority in number constituting at least 75% by value of the relevant class attending and voting on the scheme approval process.
  There is no automatic moratorium from creditor actions (save as may be provided under the approved and sanctioned scheme itself) and the compromises which may be proposed are wide ranging. There are some compromises that cannot be promoted – generally proprietary rights are protected unless consent from those affected is obtained and certain liabilities relating to any recent (within the previous 12 weeks) standalone statutory moratorium are also protected. There are three stages – the court is asked to agree that a meeting of creditors (and/or members as the case may be) should be summoned to vote on the scheme (the convening hearing), the vote takes place and finally the court is asked (assuming approved by creditors/members) to approve the scheme (the sanction hearing). At the convening hearing the court considers whether it has jurisdiction and whether the class constitution is appropriate. At the sanction hearing the court considers whether the statutory requirements have been met, whether the relevnt majorities for approval have been obtained, whether the scheme is ‘fair’ and whether there are any other issues of relevance that might impact whether to sanction the scheme. 
  There is a key procedural difference in Scottish law whereby the appointment of a court ‘Reporter’ will be required.  The Reporter will be a Scottish qualified solicitor who will verify the accuracy of the court petition and check the procedural steps have been followed correctly.  The fee for such a Reporter can be substantial.  The process may also take approximately two weeks longer than it would in (English) Companies Court due to a two week period being required for the petition to be answered following advertisement of the petition.
• Restructuring Plan (Part 26A Companies Act 2006) – the process is very similar to that for a scheme of arrangement noted above but there are some important differences. 
  A plan is only available to companies facing financial difficulties. Whilst the voting process requires the same class constitution considerations and the same majorities for approval as for schemes (although under a plan a majority in number of those approving within a class is not a requirement), under a plan it is possible, subject to certain conditions, to implement a plan despite a dissenting class not approving it (the so-called cross class cram down). One of those conditions involves demonstrating to the court’s satisfaction that the crammed down creditor class is no worse off under the plan than it would have been in the event of the relevant alternative to the plan occurring (most often some form of insolvency process). That consideration of what is the relevant alternative to the plan and the value attributable the crammed down class in such alternative are clearly potential battlefields when asking the court to exercise its cram down discretion. 
  Because of the cross-class cram down possibility in a plan, for companies in financial difficulties, a restructuring via a plan will often be preferred over a scheme.
  As with a scheme of arrangement under part 26 of the Companies Act 2006, a Restructuring Plan commenced in Scotland will also require the appointment of a court Reporter.
• Company voluntary arrangement (Part I Insolvency Act 1986) – as noted only the debtor can issue proposals seeking a compromise or composition with creditors by way of a company voluntary arrangement although proposals can be issued by the debtor’s liquidator or administrator. The terms that can be included in an arrangement are very broad subject to some limitations noted below.
  All creditors are entitled to vote on the proposals and although the debtor’s members are also entitled to vote on the proposals the wishes of the creditors prevail.  No court approval is needed for the proposals to be issued and creditor approval sought. Like with schemes and plans there is no automatic creditor moratorium unless and until the proposals containing such a provision are approved. There is no need for the court to be involved after voting unless a challenge is made to the fairness of the proposals or on the basis of some irregularity in the process.
  There are no classes in a company voluntary arrangement – all creditors vote as a single group. To be approved 75% or more by value of creditors voting must approve (and as long as not more than 50% of unconnected creditors vote against) and once so approved the terms of the arrangement are binding on all creditors. The rights of secured creditors to take enforcement action cannot be compromised without that creditor’s consent and, as with schemes and plans, proprietary rights are generally protected. Also, as with schemes and plans certain statutory moratorium related debts (if there has been such a moratorium in the previous 12 weeks) cannot be compromised. There are also protections for preferential creditors whose priority as against ordinary creditors (and amongst themselves) cannot be altered without consent.  
  The challenge period for a creditor to take action for unfairness or irregularity is within 28 days after proposals are approved. Court involvement requires positive intervention by a creditor otherwise the court does not consider the appropriateness or effectiveness of the terms of the arrangement.

4. Are there different types of creditors and what is the significance of the differences between them?

As noted under paragraph 3 above under the summary of each of the three restructuring procedures, there is some significance to different types of creditors. Generally, in plans and schemes, secured creditors can be compromised if the relevant class voting approves or the court exercises cram down discretion where relevant. There is however no automatic creditor moratorium in either process. Equally it is technically possible to compromise preferential creditors in schemes and plans, but the court is not quick to exercise class cram down in a restructuring plan, not least given preferential claims are mostly dominated by taxation liabilities. In a company voluntary arrangement neither the rights of a secured creditor to take enforcement action nor the priority afforded to preferential creditors can be compromised without the relevant creditor’s consent (regardless of the approval of proposals attempting to suggest otherwise).

5. Is there any obligation to initiate restructuring/insolvency proceedings? For whom does this obligation exist and under what conditions? What are the consequences if this obligation is violated?

There is no obligation to commence an insolvency or restructuring process. However, there can be a risk of personal liability for directors who trade beyond the point of no return and worsen the creditor position in so doing such that directors will seek the protection of a process to avoid or mitigate such risk.   

6. What are the main duties of the representative bodies in connection with restructuring proceedings?

Generally, the members of a company have no duties in connection with restructuring proceedings although may be heavily involved as means of protecting equity value.  The main responsibilities (and risk) lie with the directors of the debtor company. Those responsibilities are mainly against the backdrop of the general duties of directors, both statutory and fiduciary, in promoting the best interests of the company of which they are directors in an appropriate manner. Clearly where the debtor seeks the implementation of a plan, scheme or voluntary arrangement it is primarily the responsibility of the directors collectively to undertake the process appropriately.

7. What are the main duties of shareholders in connection with restructuring proceedings?

Generally, there are no shareholder duties in connection with restructuring proceedings.

1.  What is the primary legislation governing insolvency proceedings in your jurisdiction?

The Insolvency Act 1986 as augmented by the Insolvency (Scotland) (Receivership and Winding up) Rules 2018 and the Insolvency (Scotland) (Company Voluntary Arrangements and Administration) Rules 2018.

2. How are insolvency proceedings initiated?

By the debtor itself or its members (in or out of court) or alternatively any creditor can commence an insolvency proceeding by application to the court. The exception to this is that a secured creditor holding a relevant qualifying floating charge can appoint an administrator to a debtor out of court.

English law also has a private enforcement remedy for secured lenders whereby a lender can, on default, appoint a receiver over certain secured assets of the debtor. The ability to appoint a receiver to certain secured assets does not exist in Scotland.  There is no Scottish equivalent to the English concept of ‘fixed charge’ receivership,

Where the lender appoints the receiver over the whole or substantially the whole of a debtor’s business and assets the Insolvency Act 1986 gives such a receiver a number of statutory powers and imposes certain obligations on the receiver. Appointing such a receiver over the whole or substantially the whole of a debtor’s assets (known as an administrative receiver) is generally now prohibited under Scottish law but with certain notable exceptions.  In prohibiting (in the main) secured lenders from appointing administrative receivers, the UK government instead gave lenders with qualifying floating charge security the right to appoint administrators to a debtor out of court (subject to certain conditions) where hitherto creditors could only apply to court for administration (and apart from this power to certain secured lenders all other creditors must still so apply). 

3. What are the legal reasons for insolvency in your country?

Normally insolvency is demonstrated by the inability to pay debts as they fall due or by a deficiency of assets to liabilities (the cash flow test and balance sheet test respectively). But there is no legal requirement to initiate an insolvency process even if both tests are satisfied.  A failure to initiate insolvency proceedings may however involve a risk of personal liability for the directors of the debtor.

4. Which different types of insolvency proceedings exist and what are their characteristics?

Winding up or liquidation

This may be voluntary (commenced by shareholder resolution, no court involvement) or compulsory (by the debtor or a creditor applying to court on the basis of debtor insolvency). There are also grounds for members applying to court on the basis of unfair prejudice (normally in the context of a shareholder dispute of some kind) and regulators also enjoy powers to seek winding up in the context of their regulatory oversight. The liquidation commences when the shareholder resolution is passed or, when made by court order, dates back to when the application for the liquidation was issued. Generally, the court is asked to accept the debtor is insolvent.  

Liquidation is the process of realising assets for distribution to creditors. It is the precursor to the end of the debtor company and so only involves short term continued trading, if at all, for this purpose.

Liquidators take over control of the debtor from its directors and are given broad powers of investigation and information gathering and along with administrators (see below) unique powers to bring certain claims against directors or third parties where the estate has been depleted by inappropriate conduct or transactions in the period before commencement. 

Administration

Administration may be commenced by the directors or members of a debtor (in or out of court) or by creditors on application to court. The exception is that a secured creditor holding a qualifying floating charge may also appoint an administrator out of court.
 
Save for a secured creditor appointment (when the creditor need only show its security is enforceable), the basis of an administration appointment is that the debtor is or is likely to be insolvent and the statutory purpose is capable of achievement. Again, certain regulators also have the power to seek an administration order from the court, often by way of a ‘special administration’ regime for key sectors or industries or in the context of consumer protection. 

The statutory purpose for which administrators may be appointed (ignoring the specifics of special administrations) is broken down into a hierarchy of three objectives - rescue of the debtor entity or if not reasonably achievable a better realisation than liquidation or finally if neither can be achieved a return to one or more secured or preferential creditors. An administrator has a duty to end the administration if none of these of objectives can be achieved or indeed if the objective has been achieved. 

Administrators also take over control of the debtor from its directors and may continue to trade all or part of the debtor’s business. They are given broad powers very similar to a liquidator – so powers to investigate antecedent transactions and to investigate improper conduct and prior transactions. There are certain claims an administrator may pursue which are unique to the insolvency process (again similar to liquidators) and which the debtor would not otherwise have.

It is also possible for there to be a distributing administration, very similar to a liquidation, where the administrator realises assets, agrees the claims of creditors and effects distributions. More commonly however the administration progresses to a liquidation for distributions. This is mainly because administrations have an initial life of 12 months albeit capable of extension in appropriate circumstances.  

5. Are there different types of creditors and what is the significance of the differences between them?

Creditors the same as those identified at paragraph 4 under Amicable Restructuring. However, creditors incurred in the currency of the liquidation or administration are generally afforded the protection of being paid first from the estate (assuming sufficient assets) before any distributions are made to unsecured or preferential creditors.

The priority afforded to secured creditors is retained but a distinction is made between realisations from fixed charge security assets (commonly real estate and intellectual property) as opposed to realisations from assets subject to a floating charge security (commonly book debts/receivables and stock in trade). Fixed charge realisations are remitted to the security holder net of realisation costs but the order of payment out of floating charge receipts is first to the liabilities incurred in the estate operations, secondly to the remuneration and general expenses of the administration or liquidation (which may include taxation liabilities), next to preferential creditors and lastly to the floating charge holder.

There is in addition a ring-fenced fund (the ‘prescribed part’) created out of the net floating charge receipts (after the incurred estate liabilities, costs, expenses, remuneration of the liquidator or administrator and payment of preferential creditors) set aside for payment pro rata to unsecured creditors. This is calculated as 50% of the first £10,000 and 20% of the balance of any remaining net floating charge receipts up to a maximum of £800,000.

Any remaining realisations go to unsecured creditors, then in payment of interest to unsecured and preferential creditors and finally to shareholders.

6. Is a solvent liquidation of the company an alternative to regular insolvency proceedings?

A solvent liquidation can be used to end the debtor’s existence by paying off any creditors and distributing remaining assets to the shareholders. A solvent liquidation is always a voluntary liquidation (so begun by shareholder resolution with no court involvement) and requires a declaration from the directors, sworn before commencement of the liquidation, that the debtor will be able to pay all of its creditors in full within 12 months, including any interest payable.

1. If a lender wants to monitor its borrower very closely (i.e. more closely than the usual information covenants in the credit agreement require), what options are there?

It is common for lenders, usually in return for providing covenant breach waivers, providing new money or extending interest or capital payments, to require the borrower’s agreement to a variety of potential monitoring or enhanced information options. At its most basic this involves additional contractual information requirements and regular reporting in a variety of formats but may also include:

• setting out the circumstances in which the lender may commission an independent business review (IBR) of the borrower. This usually involves a third-party accountant taking a high level or deeper dive into the borrower’s business with the customer’s cooperation, providing access to borrower personnel and financial information. An IBR usually focuses on cash flow and cash constraints suitably sensitised by the accountant. It is also often accompanied by enhanced contractual information requirements and may, depending on circumstances, also require an accelerated M&A with lender acceptable oversight. It is not unusual for the accountant undertaking the IBR to provide additional support to the borrower on an ongoing basis around the quality and frequency of its management and financial information. 
• the lenders may require the appointment of a board observer or a chief restructuring officer (CRO). The latter will owe his duties in the same way as all other directors so whilst he may be appointed at the instance of the lenders, he is not the lender’s appointee. The appointment is often accompanied by a specific scope setting out the borrower’s commitment to the CRO’s ability to provide certain information to, and to consult with, the lender on behalf of the borrower, amongst other specific tasks (for example preparing the borrower for disposal of part or all of its business or restructuring the existing business). A CRO requirement is most often used where there is potential value in a restructured business but the existing board of directors does not have the appropriate skill sets and/or the desire to undertake the steps perceived as necessary by the lender.
• If it is clear that a disposal represents the optimum outcome for a lender then the lender will usually require appointment of acceptable M&A advisers to the borrower (likely to be the same firm which has undertaken any prior IBR if relevant although not always). That appointment will also carry with it the obligation to provide information to the lender around the sales process and it usually managed closely by the appointed adviser.

The backdrop to securing these types of enhanced monitoring and information obligations is usually that the lender has security capable of enforcement so that the alternative to the borrower refusing to cooperate may well be an enforcement or insolvency process. Even without security a lender with the power to accelerate enjoys commercial leverage. Clearly, if an amicable restructuring is feasible the enhanced information flow will be a necessary element in securing lender support which is almost certain to be needed. 

2. What issues arise if a creditor extends credit facilities or offers support conditional on additional or extended guarantees to a company in financial difficulties and/or takes asset security?

Generally extending credit facilities does not create difficulties for lenders beyond normal commercial risks. In isolation additional funding is not considered to deplete the estate in subsequent insolvency proceedings.

Instead, in the period prior to a subsequent insolvency, the focus is on transactions where the value received by the debtor is significantly less than the value given by it to the lender and/or the lender is deliberately preferred over other creditors.

There are a number of specific insolvency antecedent claw back provisions which may impact lenders in such circumstances –

• Floating charges given in the 12 months prior to a liquidation or administration commencing (24 months if lender and borrower are connected parties) are invalid except to the extent of fresh consideration provided to the borrower at the time of or subsequent to the granting of the security. So ‘old’ indebtedness may not be secured by the floating charge in such circumstances.
• Gratuitous alienations (sometimes described as transactions at undervalue) in the 2-year period prior to insolvency commencing (5 years if lender and borrower are connected parties) may also be vulnerable, subject to certain statutory ingredients and defences. There is case law authority (which is English case law that is likely to be persuasive in Scotland) to suggest that the giving of security cannot amount to an undervalue because it is a reordering of priorities with respect to an asset rather than a disposition if it so does not deplete the insolvency estate. The same may not necessarily follow for the giving of guarantees where the benefit to the borrower may not be easily assessed.
• Giving security or a guarantee may amount to a preference to the lender (look back period for both connected and unconnected parties’ is 6 months prior to insolvency) again subject to statutory requirements.
• There is also a commercial benefit consideration in giving guarantees and in any transaction with a lender where a borrower is giving something to the lender whilst it is in financial difficulties, and receiving insufficient in return, there may be implications for the directors personally in so doing even outside of the specific antecedent transaction provisions noted above. Each transaction must be considered on its merits in the context of the surrounding circumstances.

1. How does a lender sell a loan?

Unless a loan is expressed to be non-assignable or incapable of transfer, Scottish law generally recognises the free assignability of loans, subject to the requirement that the assignation needs to be notified (‘intimated’) to the borrower to become fully effective. In more sophisticated debt arrangements and certainly with syndicated loans there is usually a process set out in the debt documentation confirming whether there any prohibited assignees to whom a loan may not be sold and the documents required for valid assignment. Whilst specific loans can and often are traded individually it is not uncommon for lenders to group non-performing loans together and seek to dispose of them as a portfolio. That is usually under a process inviting expressions of interest and indicative terms, moving through subsequent rounds of bidding as diligence is undertaken, price and portfolio content firmed up and acceptable potential assignees identified. There are sometimes related servicing agreements to be negotiated and various other ancillary documents depending on the circumstances.

Other than the potential need to register in public registers the transfer of security interests held for any of the sold loans (although that can take a considerable time and buyer and seller often provide for the seller to hold registered security to the buyer’s order until actual transfer), and the terms of the contractual loan documentation, Scottish law does not generally superimpose any additional obligations on loan sales.

2. If the underlying credit agreement prohibits transfer or assignment (i.e. a change in the lender of record), how else – if at all – can a lender transfer the economic risk and/or benefit in the loan? For instance, are sub-participation agreements allowed under the law of your jurisdiction?

The most common way to transfer economic interest if transfer or assignment is prohibited is by way of loan sub-participation where the seller remains lender of record and reached a contractual arrangement with the buyer to pass on the economic benefit to the buyer, subject to the costs of the seller continuing to service the loans with the underlying borrower.

It may also be possible to enter into some form of synthetic structure to transfer the economic interest such as a derivative swap transaction rather than acquire an interest in the loan.

3. Regulatory issues: is any form of licence or prior authorisation from any regulatory authority required for the purchase, sale and/or transfer of loans? Does it fall within the definition of providing banking or financial services in the territory of the assignor or the borrower?

Generally, to sell and purchase loans involving UK entities there are no regulatory approvals required. However, depending on the make-up of the loans being acquired, there may be a number of regulatory hurdles to be overcome when operating the acquired loans post-acquisition such as approval when dealing with regulated assets (such as residential mortgages with consumers), banking or regulatory approvals when the transaction involves the potential for making further advances where there are undrawn commitments or revolving credit facilities, and related issues over data protection requirements and securities laws generally. Also, certain servicing activities may fall under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001.

Where a licence or regulatory approval of some kind is needed this is often solved by using a licensed third party to service and even sometimes hold title to the asset. The EU Directive on Non-performing Loans is not applicable in the UK.