The COVID-19 crisis has disrupted and will disrupt collections for existing European non-performing loan ("NPL") portfolios and has put many planned transactions on ice. Banks have been prioritising COVID-19-related forbearance measures and largely putting deleveraging on hold ahead of better market conditions. Concurrently, European governments have been focused on flattening the curve of impending insolvencies, as we see a move to a more debtor-friendly legal environment across Europe.
2021 is widely expected to herald a new wave of NPLs, both as a result of new NPL activity triggered by the crisis, but also to deal with existing transactions. With new measures that set minimum capital coverage requirements for NPLs across Europe coming into place in 2021, known as the "prudential backstop," banks will be further incentivised to remove NPLs that are sitting on their balance sheets. Although the NPL ratio in the U.K. could rise from around 1.2% to at least three times that figure as a result of the current crisis, at the same time, in the U.K., the biggest set of insolvency-related reforms since 2002 have just been unveiled in the form of the Corporate Governance and Insolvency Act 2020 ("CIGA 2020"). CIGA 2020 heralds a new chapter in U.K. insolvency law, introducing tools in order to rescue a company as a going concern, which include a new moratorium that is designed to give struggling companies breathing space whilst seeking to restructure their debts (a "Debtor-in-Possession Moratorium"), as well as a new restructuring tool (a "Restructuring Plan") which can bind all creditors, including secured creditors and junior classes of creditors even if they vote against the plan. The impact of these new measures will need to be considered in the context of investors' base cases, as well as in the stress-testing analysis inherent in any rated transaction, for example, a public NPL securitisation.
Although investors in an NPL transaction might wish to monetise their investment using a mixture of strategies, including agreeing a discounted payoff in respect of particular assets with the debtors, or via direct action against the debtors themselves, one of the key considerations for a buyer of a portfolio of NPLs secured over assets of an English company in the U.K. is whether there are any circumstances in which enforcement of the security over the asset (for example, by appointing a fixed charge receiver or a receiver under the Law of Property Act 1925 ("LPA")) might be delayed or prevented. In this regard, it is important from an investor's perspective to consider both the effect of the appointment of an insolvency practitioner in respect of an English company on the enforcement of a fixed charge over real estate granted by that company, as well as the ways in which restructuring tools, including the new measures introduced by CIGA 2020, might impact an investor's recovery analysis. We set out some high-level considerations that buy-side investors (an "NPL investor") should bear in mind at the due diligence and valuation stage of a secured real estate NPL portfolio acquisition in light of debtor-protective measures in the U.K. and U.K. insolvency law more widely.
In the following section, we have considered each of the insolvency processes available to U.K. companies and set out some of the key considerations for NPL investors.
This section assumes that: (i) the relevant security document granted by the company (the "debtor" or the "company") contains a floating charge over all or substantially all of the assets of the debtor (a "QFC"); (ii) the debtor is an English company and the security granted by it is registered at Companies House; (iii) the real estate owned by the debtor is situated in England and Wales and has a first fixed charge registered against its title at Land Registry; and (iv) due diligence either reveals filings for the relevant insolvency practitioner or that the debtor has otherwise entered into the relevant process described below. The below information is also relevant to where the debtor enters the applicable process at a later stage.
1.1 Who can commence the administration process?
(a) the holder of a QFC;
(b) the directors;
(c) the company; and
(d) any creditor by an application to court.
Importantly, an administrator can be appointed by the "out-of-court" process by the holders of a qualifying floating charge, the directors or the company by filing the requisite notices at court, which is an extremely streamlined process.
1.2 Who does the administrator act for?
The administrator acts as agent for the company in the best interests of the creditors of the company (as a whole).
1.3 What is the purpose of the administration process?
The purpose of the administration process, in order of priority, is:
(a) the rescue of the company;
(b) if the first objective is not reasonably practicable to achieve, achieving a better result for the company's creditors as a whole; and
(c) if the first two objectives are not reasonably practicable to achieve, realising the property of the company in order to make a distribution to one or more secured creditors.
1.4 Are creditors prevented from taking enforcement action?
Yes. When a company enters administration, it becomes subject to a statutory moratorium (an "Administration Moratorium") that prevents creditors, including NPL investors, from enforcing their claims against the company. This allows the administrator time to reorganise the company's affairs or conduct an orderly realisation of the company's assets.
The Administration Moratorium restricts the ability of third parties (particularly the company's creditors such as NPL investors) to enforce their rights against the company, without the prior consent of the administrator or the consent of the court. The Administration Moratorium does not alter the substantive rights of a party against a company in administration, but simply suspends the exercise of those rights during the administration.
1.5 Can the appointer block the appointment of an LPA receiver?
Yes. In addition, a company can enter administration, by either the court route or the out-of-court route, despite a secured creditor such as an NPL investor having appointed a receiver to certain of the company's assets. Any receiver of part of the company's property must vacate office if the administrator requires him or her to do so.
1.6 Can the rights of creditors be released/compromised?
Creditors will receive a distribution from the realisation of the company's assets in the statutory order of priority. The administrator can sell assets subject to a floating charge but cannot sell assets subject to a fixed charge without the consent of the secured creditor or the consent of the court.
1.7 Are there any other key considerations for an NPL investor?
An administrator may dispose of property that is subject to floating charge (including a QFC) without the consent of the relevant secured creditor (e.g., the NPL investor) or the formal release of the charge. However, in these circumstances the NPL investor does not lose its priority in terms of the proceeds from the disposal of the assets subject to the floating charge. An NPL investor should also be aware that the proceeds from the disposal of assets subject to a floating charge are subject to a "prescribed part" which provides for a percentage of such value to be set aside to be paid to unsecured creditors. The prescribed part is calculated as 10% of the first £10,000 and 20% of anything thereafter subject to a limit of £800,000 where the first ranking floating charge was created after 6 April 2020 or £600,000 if created before that date.
With the prior approval of the court, an administrator can dispose of property subject to a fixed charge without the consent of the NPL investor in this example, provided the disposal promotes the administration's purpose and the net disposal proceeds are applied in repayment of the NPL.
2. Administrative Receivership
2.1 Who can commence the administrative receivership process?
(a) the holder of a pre-2003 QFC; and
(b) in limited circumstances, holders of a post-2003 QFC (certain capital markets transactions, public private partnerships, utilities, certain urban regeneration projects, certain project finance transactions, financial market transactions, social landlords or protected railway companies).
2.2 Who does the administrative receiver act for?
The administrative receiver acts as agent for the appointer.
2.3 What is the purpose of the process?
The purpose of appointing an administrative receiver is to seek repayment of the secured debt.
2.4 Are creditors prevented from taking enforcement action?
No. Creditors (including NPL investors) may begin or continue any legal action against the company, including petitioning for its liquidation, while the company is in administrative receivership.
2.5 Can the appointer block the appointment of an LPA receiver?
No. A creditor with the right to appoint an administrative receiver cannot prevent the appointment of a receiver over an asset (by, e.g., an NPL investor) and will not be able to delay or frustrate the enforcement by an NPL investor of a fixed charge registered at the Land Registry.
2.6 Can the rights of creditors be released/compromised?
Creditors will receive a distribution from the realisation of the company's assets in the statutory order of priority. An administrative receiver can sell assets subject to a floating charge but cannot sell assets subject to a fixed charge without the consent of the secured creditor or the consent of the court.
2.7 Are there any other key considerations for an NPL investor?
Whilst an administrative receiver cannot prevent the appointment of an LPA receiver over a fixed asset, nor frustrate the enforcement of fixed security, it can seek to influence the disposal process and block the appointment of an administrator, and apply to the court for an order to dispose of a property free of any security which is prior or equal-ranking to that of their appointer (which could be applicable to an NPL investor).
3. Debtor-in-Possession Moratorium
3.1 Who can commence a Debtor-in-Possession Moratorium?
The directors only.
3.2 Who does the insolvency practitioner act for?
The insolvency practitioner, known as the 'monitor,' acts for the Company.
3.3 What is the purpose of the process?
The Debtor-in-Possession Moratorium grants the company some breathing space with a view to the rescue of the company as a going concern. The moratorium can last up to 20 business days and can be extended for a further 20 business days up to a period of 12 months (with the consent of creditors or the court).
3.4 Are creditors prevented from taking enforcement action?
Yes. A Debtor-in-Possession Moratorium is a stand-alone procedure (unconnected to an Administration Moratorium) which would be available if the company is, or likely to become, unable to pay its debts. The directors remain in charge of the company, but the process and company conduct is overseen by the monitor who is required to certify that it is likely that the Debtor-in-Possession Moratorium will result in the rescue of the company as a going concern.
A Debtor-in-Possession Moratorium provides the company with a payment holiday from certain debts which fell due before the process or fall due during the process but relate to obligations incurred pre-process. Certain debts are excluded and must be paid as they fall due during the moratorium period (including liabilities arising under an NPL). If such payments are not made, the monitor may terminate the moratorium.
The moratorium will restrict the NPL lender from enforcing its security over the company's property save that any security arising under a financial collateral arrangement within the meaning of regulation 3 of the Financial Collateral Arrangement (No. 2) Regulations 2003. Therefore, provided any security granted to the NPL lender meets the requirements of a financial collateral arrangement and is over financial collateral (i.e., cash, shares), an NPL lender would be capable of enforcing its security over those assets.
3.5 Can the appointer block the appointment of an LPA receiver?
Yes. The Debtor-in-Possession Moratorium is similar to an Administration Moratorium insofar as action against the company is concerned. The Debtor-in-Possession Moratorium impacts on secured creditors' abilities (such as an NPL investor) to protect and enforce their security. Security cannot be enforced during a Debtor-in-Possession Moratorium period (which may last for up to 12 months) without court consent. However, security created during a Debtor-in-Possession Moratorium with monitored consent can be enforced without court consent, and NPL debts are excluded from the Debtor-in-Possession Moratorium and must be paid as they fall due which effectively allows the NPL investor the ability to bring any Debtor-in-Possession Moratorium to an end.
3.6 Can the rights of creditors be released/compromised?
The Debtor-In-Possession Moratorium itself does not provide a mechanism to compromise claims of creditors but provides breathing space in order to implement a restructuring.
3.7 Are there any other key considerations for an NPL investor?
The Debtor-in-Possession Moratorium can be obtained by filing relevant documents at court without notice to secured creditors, who will only be given notice by the monitor after the Debtor-in-Possession Moratorium becomes effective.
The payment holiday provided by the Debtor-in-Possession Moratorium applies to pre-moratorium debts that have fallen due before the moratorium or fall due during the moratorium certain to some exclusions (including debts and other liabilities arising under a contract or other instrument involving financial services does not apply to certain debts or liabilities arising under a contract or other instrument involving financial services, the definition of which includes lending or guarantees). As NPL debts are excluded from the Debtor-in-Possession Moratorium payment holiday, this allows an NPL investor to regain some control of the process in the event of failure to pay. If the company cannot pay, the monitor will either have to bring the Debtor-in-Possession Moratorium to an end (as they would unlikely be able to continue to confirm that the company could be rescued as a going concern) or the company will need to negotiate with the NPL investor to agree a stay. If the company cannot pay or a stay cannot be agreed, then acceleration of the NPL would require the monitor to bring an end to the Debtor-in-Possession Moratorium and enable the NPL investor to pursue an administration appointment or other enforcement process and/or enforcement of any guarantee. Similarly, making demand under a guarantee against a guarantor of an NPL would still be permitted even if the guarantor company was subject to a Debtor-in-Possession Moratorium.
4. LPA or Fixed Charge Receivership
4.1 Who can commence the LPA or charge receivership process?
A fixed charge holder.
4.2 Who does the insolvency practitioner act for?
The LPA or fixed charge receiver acts as agent for the appointer.
4.3 What is the purpose of the process?
The purpose is to seek repayment of the secured debt.
4.4 Are creditors prevented from taking enforcement action?
4.5 Can the rights of creditors be released/compromised?
The LPA or fixed charge receiver will seek to realise the value of the fixed charge asset over which they have been appointed but do not alter the rights of creditors of the company.
4.6 Are there any other key considerations for an NPL investor?
If an NPL investor's enforcement strategy is to take custody of assets, sell those assets and apply the proceeds of sale in satisfaction of the NPL or to collect the rents relating to a property, it may seek to appoint a receiver to the assets via the contractual terms of the relevant security documents. In this case the terms of the receivership (including the powers of the receiver) are a function of the security documents and the documents that affect the appointment.
This is in addition to the statutory right of an NPL investor to appoint a receiver to the charged assets under the LPA.
5. Restructuring Plan
5.1 Who can commence the Restructuring Plan process?
(a) the company;
(b) the administrator (if the company is in administration);
(c) the liquidator (if the company is in liquidation);
(d) the creditors (in practice this may be difficult); and
(e) the shareholders (in practice this may be difficult).
5.2 What is the purpose of the process?
The Restructuring Plan is a restructuring tool to be used with a view to eliminating, reducing or preventing, or mitigating the effect of, any financial difficulties of the company.
5.3 Are creditors prevented from taking enforcement action?
No, although a Debtor-in-Possession Moratorium is available, subject to eligibility, to protect a company while it prepares its proposal.
5.4 Can the rights of creditors be released/compromised?
In the event that the requisite majority of creditors approves the Restructuring Plan, the rights of creditors may be compromised in accordance with the terms of the Restructuring Plan.
5.5 Are there any other key considerations for an NPL investor?
Like schemes of arrangement, affected secured (including NPL investors) and unsecured creditors may be bound by a Restructuring Plan provided they are included within the Restructuring Plan, even if they vote against it, as long as the requisite majority votes are achieved. In the absence of agreement by all classes, the Restructuring Plan allows for the plan to be passed even if one or more classes votes against it (i.e., those classes are "crammed down"). This could mean that a Restructuring Plan is voted through by a single (even a junior) class of members/creditors, even though all the other classes dissent.
A junior class of creditors could potentially force a cram down (or cram up) on a more senior dissenting class of creditors (including an NPL investor), subject to: (i) the senior creditors being no worse off under the relevant alternative (this goes some way to preserving the waterfall of priorities), (ii) the junior creditors retaining a genuine economic interest and (iii) the ultimate discretion of the court. Such "cram-up" scenarios are a theoretical possibility, although it remains to be seen how useful or practicable that would be as the procedure is yet untested.
Valuation will be key in the new process both in assessing the comparison for creditors being crammed down as part of a plan and also when assessing which creditors are "out-of-the-money" and can be excluded from the voting process.
6.1 Who can commence the CVA process?
(a) The directors (if not in administration or liquidation); and
(b) the administrator or liquidator (if in administration or liquidation, as the case may be).
6.2 Who does the insolvency practitioner act for?
An insolvency practitioner will take on a number of roles at different stages, including: (i) advising the directors with the preparation of the CVA proposal; (ii) as nominee certify that there is a reasonable prospect of the CVA being approved and implemented and whether the CVA should be considered by the shareholders and creditors; and (iii) as a supervisor, following approval of the CVA to ensure that the CVA is implemented in accordance with its terms.
6.3 What is the purpose of the process?
The aim of a CVA is for a company in financial difficulty to avoid liquidation or administration by making a contractual compromise or arrangement with its creditors and shareholders. A CVA may also be used to help implement a compromise between the company and its creditors while the company is being administered through a formal insolvency procedure such as administration.
6.4 Are creditors prevented from taking enforcement action?
During the proposal process, creditors are not prevented from taking enforcement action unless a small company moratorium (or Debtor-in-Possession Moratorium) has first been obtained. In the absence of a formal moratorium, a secured NPL lender may therefore seek to enforce its security irrespective of whether a CVA has been proposed.
In the event an unsecured creditor seeks to wind-up the company after a proposal has been made but before approval, the court may stay such petition to see whether the CVA may be approved. Once approved, the terms of a CVA bind all parties who were eligible to vote on the proposal. These parties usually include all unsecured creditors, even those who were not notified of the CVA. Therefore, a CVA, once approved, binds both known and unknown creditors in relation to debts which the CVA is drafted to encompass. The CVA cannot affect the ability of secured creditors to take enforcement action in relation to its security without its consent.
6.5 Can the appointer block the appointment of an LPA receiver?
In the absence of a Debtor-in-Possession Moratorium or an Administration Moratorium (which includes a moratorium on enforcement including the appointment of LPA receivers), such an appointment cannot be blocked. Additionally, following the CVA in the event the company emerges from administration or the Debtor-in-Possession Moratorium ends, the CVA itself cannot restrict the ability of secured creditors to exercise their rights of enforcement without their consent. However, the appointment of an LPA receiver may be blocked periodically if: (i) the company combines the CVA procedure coupled with administration (and thus availing of the statutory Administration Moratorium); or (ii) the company puts forward a CVA proposal while the company is in a Debtor-in-Possession Moratorium, which will automatically be extended during the period in which the CVA is pending.
6.6 Can the rights of creditors be released/compromised?
If approved by the requisite majority of unsecured creditors, the rights of unsecured creditors may be compromised, released or altered in accordance with the terms of the CVA. A CVA cannot affect the rights of secured creditors such as an NPL investor in the fact pattern we have assumed without their consent.
6.7 Are there any other key considerations for an NPL investor?
A CVA cannot be used to alter the rights of secured creditors such as an NPL investor in our example or to alter a preferential creditors priority without the consent of those creditors affected. Additionally, a CVA does not prevent a secured creditor such as an NPL investor in our example enforcing its security (unless the CVA is combined with administration (see above) or the secured creditor attempts to enforce the security in the period while the company is in a Debtor-in-Possession Moratorium and the CVA is pending (see above)).
The expectation from the market is that the Debtor-in-Possession Moratorium will work alongside the existing CVA procedure and so Debtor-in-Possession Moratoria could be used as a protective shield while a CVA is formulated. However, it should be noted that secured creditors have some leverage because in any CVA that is proposed within 12 weeks of a Debtor-in-Possession Moratorium, the holders of debts which are not subject to a payment holiday during a Debtor-in-Possession Moratorium (such as NPLs) have, in effect, a veto right in respect of the CVA as neither the company nor the creditors may approve a CVA unless these debts are paid in full (unless the creditors consent).
When compared to the new Restructuring Plan procedure introduced under CIGA 2020, CVAs will still have a place for dealing with landlord liabilities, as they are better than Restructuring Plans given there is less court involvement and any challenge is limited to 28 days. However, where a company wants to compromise several classes of creditors (e.g., financial, trade and landlords), the Restructuring Plan may provide a more effective solution as all can be dealt with together in one plan.
7. Scheme of Arrangement
7.1 Who can commence the scheme of arrangement process?
(a) the company;
(b) the administrator (if the company is in administration);
(c) the liquidator (if the company is in liquidation); and
(d) any creditor or shareholder of the company.
7.2 What is the purpose of the process?
The aim of a scheme of arrangement is for a company to make a binding compromise or arrangement with its creditors and/or shareholders or any class of them. It is not necessary for a company to be insolvent or to be suffering any form of financial distress.
7.3 Are creditors prevented from taking enforcement action?
There is no formal procedure by which a company proposing a scheme of arrangement can obtain a stay of any enforcement action. The courts may, however, be prepared to stay specific attempts at enforcement that may undermine the company's ability to restructure through a scheme to ensure that all creditors are treated equally. This does not amount to an automatic moratorium.
7.4 Can the appointer block the appointment of an LPA receiver?
In the absence of a Debtor-in-Possession Moratorium or an Administration Moratorium (which includes a moratorium on enforcement including the appointment of LPA receivers), such an appointment cannot be blocked. The appointment of an LPA receiver may be blocked during the period in which the company puts forward a scheme of arrangement proposal while the company is in a Debtor-in-Possession Moratorium, as the moratorium may be extended with the consent of the court until such date as the relevant court orders are made in respect of the scheme.
Depending on: (i) the terms of the scheme; and (ii) whether the requisite thresholds have been met, the scheme could bind secured creditors against exercising their enforcement rights, including appointing an LPA receiver.
7.5 Can the rights of creditors be released/compromised?
In the event that the requisite majority of creditors or any class of them approve the scheme of arrangement, the rights of creditors of that class of creditors may be compromised in accordance with the terms of the scheme.
7.6 Are there any other key considerations for an NPL investor?
A scheme need not affect all of a company's creditors or members. A company may propose a scheme with only certain classes of creditors and leave others unaffected. Additionally, creditors belonging to different classes are required to vote on the scheme at separate class meetings of their own. If a class meeting does not approve the scheme by the requisite majorities, the members of that class will not be bound by the scheme.
Though it is not possible for the court to sanction where there is a dissenting class of creditors, there is authority for the proposition that the scheme company can exclude "out-of-the-money" creditors from a scheme of arrangement, thereby effectively cramming down those creditors.
In a scenario where a scheme follows a Debtor-in-Possession Moratorium, creditors such as NPL investors have some leverage because in any scheme of arrangement that is proposed within 12 weeks of a Debtor-in-Possession Moratorium, the holders of debts which are not subject to a payment holiday during a Debtor-in-Possession Moratorium (such as NPLs) have, in effect, a veto right in respect of the scheme as the court may not sanction the scheme if it includes provision in respect of such creditors without their consent.
* David O'Donovan, attorney trainee, also contributed to this article.
 Source: European Banking Authority - Risk Dashboard - Data as of Q1 2020.
 Source: European Banking Authority - Research Bulletin No. 71 - "COVID-19 and non-performing loans: lessons from past crises" dated 27 May 2020.