After a decisive Conservative election victory on 12 December 2019, the United Kingdom officially left the European Union on 31 January 2020, three and a half years after the referendum. However, whilst the election result provided more certainty, causing Eurozone bond yields to rise sharply, many companies remain cautious to commit to significant investment until a trade deal has been secured with Brussels.
The election result has produced a certain amount of optimism. The UK services sector experienced particularly strong growth in January 2020, with its largest upturn since mid-2018. British retailers also experienced a sales surge in January. The increase in sales has been the largest in six years, with gains across all sectors, at 5.7 per cent.
However, accountancy firm BDO warned this high street recovery may be a "false dawn". The Office for National Statistics also reported that Gross Domestic Product remained flat from October through to the end of December, with the overall growth for 2019 at 1.4 per cent.
According to insolvency firm Begbies Traynor, 126,000 London businesses exhibited signs of significant distress and more than 358,000 businesses in other UK regions were struggling. In 2019 there was a 13 per cent. rise in the number of real estate and property businesses in significant distress to 53,000. In addition, property investors were faced with a 30 per cent. rise in companies in distress, which is attributed to the falling construction output and Brexit uncertainty.
The UK and the EU started negotiations to secure a trade agreement in March 2020, with the UK setting a deadline of the end of the year. Boris Johnson stated that the UK would be open to a trading relationship with the EU comparable to Canada or Australia in a speech on 3 February 2020.
The French foreign minister, Jean-Yves Le Drian, recently said that he foresees great difficulty with negotiating trade issues and a mechanism for future relations. He expects the parties will try to "rip each other apart" in protecting their own interests.
Brown Rudnick published an in-depth update on 24 January 2020.
A timeline of Brexit negotiations:
25 February 2020
The EU27 signed off on a negotiating mandate, in order for the European Commission to have the legal authorisation to open talks with the UK.
1 March 2020
The talks between the EU and the UK commenced.
A summit is to take place to assess the progress of the negotiations. This date is also the final opportunity to request an extension of the 11-month transition period, although Johnson has pledged not to do this.
1 July 2020
Access to UK fishing waters for European fishermen is to be decided. Both sides are committed to seeking a deal by this date as part of a political declaration which Johnson made as part of his Brexit Agreement.
26 November 2020
If a trade deal is to be ratified by the end of the year, it must be negotiated, checked, translated, and presented to the European Parliament by this week. In practice this gives around six months for Britain and the EU to politically negotiate.
31 December 2020
If a trade deal is not in place by this date, Britain will fall back on to World Trade Organisation terms.
KEY POINTS FOR TRADERS
- A banking licence is not required for an investor to lend to a UK corporate. Lending is not a regulated activity under the FSMA (Regulated Activities) Order 2001.
- Debt can be transferred by way of novation or assignment but assignment may be preferable in certain circumstances, particularly where security has been granted by obligors in the borrower group in jurisdictions that do not recognise security agent/security trustee structures.
- Registration is required to perfect security such as that over land, mortgages and charges created by companies and limited liability partnerships ("LLP"s). Security interests over property should be registered at the Land Registry and security created by a company or LLP must have its particulars delivered within 21 days to Companies House.
- Notarisation may be required where an English law document is to be used overseas or a foreign law document is to be used in the UK.
- Withholding tax on interest applies at a rate of 20 per cent. unless relevant tax treaties apply.
- BREXIT CONSIDERATIONS: the transition period extends until 31 December 2020. Care should be taken when entering into trades which may remain open beyond the expiry of the transition period, or those which have settled by funded participation, particularly in respect of borrowers in jurisdictions where a banking licence is required for lending activities (such as France, Germany and Italy) as counterparties may be unable to continue to rely on UK banking licences.
The primary legislation governing the regulation of banking and financial services in the UK is the Financial Services and Markets Act 2000 ("FSMA"). The UK framework is also substantially influenced by European Regulations. There may be some changes as a result of the UK leaving the EU, but the UK Government has indicated that it will choose to retain a large amount of existing EU-derived law and regulation.
For a person to carry out banking services in the UK, a Part4A Permission is required. This is needed to carry out any "regulated activities". Regulated activities require permissions and monitoring from the Financial Conduct Authority ("FCA") and Prudential Regulation Authority.
Lending activity may fall within the Regulated Activities Order and be subject to the rules of the FCA if made to or guaranteed by an individual. Otherwise lending is not a regulated activity under this system.
Any institution currently relying on a banking licence granted by the FCA may be holding loans and be fronting participation agreements which may need to be transferred to a licensed entity within the EU if the UK and EU do not reach a deal on passporting rights. The loss of passporting rights is potentially the most serious issue faced by lenders. This could have cost implications and require positions to be transferred in a short time-frame (unless a UK licensed entity has already merged its company with a EU licensed entity prior to the end of the transition period). A more detailed consideration of this issue can be found here.
METHOD OF TRANSFER
Facility agreements for UK borrowers often contain contractual restrictions on transfer. In recent years, restrictions on transfers to loan-to-own/distressed investors have become increasingly prevalent, with such transfers (and even funded participations with such parties) requiring borrower consent.
Novation and assignment are both appropriate methods of transfer under English law. In choosing between the two, consideration should be given to the full borrower group and location of the security; novations can be problematic in countries that do not recognise trusts or security agent structures (such as Spain) and may result in the release of security and resetting of hardening periods.
In such cases, assignment may be the more suitable form of transfer in addition to where (i) the borrower is insolvent, or (ii) the transferee will not owe any obligations to the borrower (e.g. if the facility is fully funded).
An assignment only transfers the benefit of a contract but not the obligations so in practice the prescribed form of assignment agreement under a facility agreement will often provide for an assumption by the assignee of the obligations of the assignor.
Notice of the assignment must be given to the borrower and any other parties against whom the assigned rights could be enforced.
Funded Participation is often used in the UK secondary market where borrower consent to a transfer is required and not obtained, or where other contractual transfer requirements cannot be satisfied (e.g. minimum transfer amount thresholds or lender eligibility criteria such as a minimum required credit rating).
Facility agreements may still impose conditions on existing lenders seeking to enter into funded participations, including the requirement for borrower consent (often limited to participations which grant voting rights to the buyer).
SECURITY AND TRUSTS/ AGENCY
Security trusts are commonly used in UK financing arrangements, with the security trustee holding security over an obligor's assets on behalf of the lenders from time to time, thereby removing the need to re-register security in conjunction with every transfer by a lender.
Agency structures can be used as an alternative where a trust structure is not appropriate. An agent facilitates contracts between principal(s) and a third party, but does not contract with the parties in its own right as a trustee does. An agent represents its principal and generally has no personal liability to third parties. Whilst they may owe fiduciary duties to their principals, the duties and liabilities agents may have are far less than for security trustees.
TAX AND STAMP DUTY CONSIDERATIONS
Withholding tax on payments of UK source interest by borrowers to foreign lenders will apply at a rate of 20 per cent. unless reduced (i) under a double tax treaty, (ii) by a domestic exemption (which may include interest paid to banks), or (iii) for lenders resident in a European jurisdiction, pursuant to an exemption under the Interest and Royalties Directive 2008 / 491 EC until the end of the Brexit transition period or, following the end of that period, under UK legislation enacted to give effect to the provisions of the Directive (and which will remain in force following Brexit, subject to any further legislation that may be introduced).
Stamp duty is payable on certain transfers in corporate transactions. Most debt securities satisfy the "exempt loan capital" exemption from stamp duty under Section 78 of the Finance Act 1986. A transfer of shares in a UK company will attract stamp duty at a rate of 0.5 per cent. of the consideration.
Notarisation is not required for transfers of UK company debt, however, it may be required where an English law document is to be used overseas (e.g. in executive enforcement proceedings against a Spanish obligor).
CORONAVIRUS: EFFECT ON GLOBAL MARKETS
The outbreak of the coronavirus ("COVID-19") is having a significant impact on the Chinese economy, which had only just begun to recover from the decline caused by the trade war tension with the US. Easing of trade tensions was expected to stabilise markets and currencies. However, now COVID-19 is disrupting the Chinese economy and impacting the value of other countries' bonds and currencies, particularly across the Asia-Pacific region. The virus outbreak has caused a reduction in Chinese purchases of US agricultural products under the Phase 1 trade deal between the US and China, which requires China to purchase agricultural commodities worth USD 40bn over the next two years.
There have recently been historic stock market falls, not seen since 2008. This is due to fears that the virus outbreak will stunt the world economy and seriously affect corporate profits. Analysts have forecast a potential impact on the global economy of a reduction in global GDP by 0.2 to 0.3 per cent. Although the outbreak may impede economic expansion in China, this may provide some strength to government debt. In addition, pharmaceutical stocks in China have benefited whilst tourism, hotels, airlines, luxury and consumer goods have all suffered.
Companies affected by the SARS outbreak in 2003 saw an impressive rebound after initial decline, particularly companies involving proximity of people. They initially suffered as a result of city and factory closures, but experienced peaks in their share prices once confidence had been restored and the virus beaten. However, the Chinese economy is four times larger now than at the time of the SARS outbreak, has a more central role in many industrial supply chains and is more interconnected with the rest of the world. This suggests any impact on the Chinese economy will have a more widespread global effect than in 2003.
Companies relying on production in China have had their supply lines affected and the volume of lost production continues to increase. As a result of the virus, Apple has been forced to issue a sales warning and has suffered a dip in stock price. There is expected to be a lasting impact on the company after the restrictions on production. COVID-19 has also disrupted business for companies such as Adidas, with its business activity in China falling 85 per cent. since 25 January 2020. Car manufacturer Mitsubishi has also caused concern after a drop in net profit attributed to COVID-19.
Reuters reported that the growth of China's economy will be the slowest since the financial crisis and Deutsche Bank forecasts that Chinese growth will be 1.5 per cent. lower in the first quarter of 2020. JP Morgan has predicted that China will recover from the disruption within the second quarter of this year and make up for the stalled economic output, whilst others fear the losses will be permanent.
In an attempt to bolster the economy, Beijing has introduced a stimulus package, including a key interest rate cut, and China's central bank has injected USD 174bn of liquidity into markets. Chinese companies have also started selling "coronavirus bonds" to boost their balance sheets. These are cheap bonds Beijing has urged companies to issue to support the country's economy. According to Huatai Securities, more than 25 businesses including airlines, drug distributors, and glassmakers have raised USD 3.4bn by selling "virus control" bonds since the start of February 2020. Regulators are encouraging the sale of the virus-linked bonds by cutting the approval process from weeks to days and urging state-backed banks to buy them. To qualify for the programme, companies must commit to spending at least 10 per cent. of the proceeds on measures to combat the epidemic.
JAGUAR LAND ROVER AUTOMOTIVE ("JLR")
JLR's production in UK factories is stalling, as they struggle to source key parts from China. The disruption of their supply chain caused by COVID-19 has caused the company to resort to flying car parts from China to the UK in suitcases. China is the world's largest auto market and other companies such as Toyota, Hyundai, Volvo and PSA (the owner of Peugeot) have disclosed that their supply chains are, or are at risk of, being disrupted by COVID-19.
JLR restarted production in China on 24 February 2020, but the situation is described as critical, with the company looking to third and fourth-choice suppliers for components. Analysts have said that it could take months for manufacturers to recover from the impact of the virus. JLR's parent, Tata Motors, has warned that the company's profits will be impacted by the outbreak. Its profit margin forecast was initially around 3 per cent. for the JLR unit in fiscal 2020, but this may have to be revised if the outbreak continues to spread.
JLR intended to issue a US dollar bond early this year and garnered enough interest for an eight-year bond with a high yield of 7 per cent. However, the company has decided to postpone the issuance, due to COVID-19 causing investors to demand higher interest rates. The company is reported to have liquidity of around USD 6bn and is not currently facing any pressure to raise new funding.
MICRO FOCUS GROUP ("MICRO FOCUS")
The company, one of Britain's largest listed technology businesses, planned to refinance an existing loan becoming due in 2021. The loan had originally supported the acquisition of Hewlett-Packard's enterprise software division three years ago, which cost USD 8.8bn.
Micro Focus intends to relaunch the refinancing once market conditions improve. The company has also begun a strategic review of its operations, but this has not yet yielded any asset sales.
The company had USD 4.3bn worth of debt outstanding at the end of October 2019 and it does not expect its financial performance to improve until 2021.
INTU PROPERTIES ("INTU")
Intu, one of the UK's largest retail landlords, is currently facing falling rents and a large debt burden. The company joins many in crisis in the UK as higher costs and consumers moving to online shopping have forced a series of insolvencies in large retailers. Traders are also now building short positions against the equity and corporate bonds issued by Intu.
Intu's largest bond is a GBP 485m security held against the Metrocentre in Gateshead. The short interest in this bond more than quadrupled in one month and on 22 January 2020 Intu revealed that it triggered a covenant on this bond, by passing a 70 per cent. threshold on its loan-to-value ratio, causing stricter conditions to kick in.
After the covenant trigger announcement, Intu's share price fell around 2.4 per cent. During the course of 2019, Intu's share price dropped over 80 per cent. overall due in part to its GBP 5bn net debt and the falling value of its shopping centres.
Intu's share price fell by a further 40 per cent. in March 2020, as it was forced to abandon its attempt to raise up to GBP 1.5bn via new equity. There is also a risk that the mall operator will breach further debt covenants this year, with analysts stating there was a rising risk that the company could face a solvency crisis.
Intu has said it will consider "alternative capital structures and asset disposals" as part of its refinancing. Lenders have agreed to extend a revolving credit facility to 2024 if Intu can raise at least GBP 1.3bn via a cash call. The loan was originally set to expire in October 2021 and would be replaced with a four year loan of GBP 440m.
MOTHERCARE UK PLC ("MOTHERCARE")
Mothercare is one of many UK highstreet retailers which collapsed in the last few years. In 2018, it received a cash injection from shareholders and proceeded with restructuring via a Company Voluntary Arrangement and two asset sales, including the Early Learning Centre for GBP 13.5m in March 2019. However, in October 2019 the company had a net debt of GBP 24.5m on its balance sheet and a decision was made in November 2019 to put the UK unit into administration.
PwC, administrators to the UK business, stated there were several interested parties, but their offers were not high enough to allow the business to continue as a going concern. However, the company made a franchise agreement with Boots UK Limited ("Boots") in December 2019 to keep the brand alive in the UK, by stocking Mothercare products in Boots stores.
In January 2020, Mothercare ceased trading, closed all stores and announced that after liquidation of its stock, it had a GBP 10m shortfall to make up to lenders.
PREMIER OIL PLC ("PREMIER OIL")
Premier Oil held scheme meetings on 12 February 2020 for the purpose of gaining approval from creditors for the schemes of arrangement for the UK North Sea Acquisitions, related funding arrangements and the extension of Premier Oil's credit facilities.
Asia Research & Capital Management ("ARCM") made a statement on 12 February 2020 that it would vote against Premier Oil's Scheme of Arrangement proposal at their creditors' meeting taking place on the same day. ARCM holds more than 15 per cent. across Premier Oil's debt instruments, making it the company's largest creditor.
Nevertheless, the resolutions were approved at each of the Scheme meetings by the relevant majorities of the Scheme Creditors:
- of the Super Senior Scheme Creditors, 81 per cent. in value of those voting approved the Schemes with 99.30 per cent. in value voting.
- of the Senior Scheme Creditors, 86 per cent. of those voting approved the Schemes with 96.51 per cent. in value voting.
However, the Schemes still require approval from the Scottish Court of Session. The sanction hearing is currently scheduled to commence on 17 March 2020.
FLYBE LIMITED ("FLYBE")
After failing to secure a GBP 100m loan, Europe's largest regional carrier Flybe has collapsed. The company held months of talks with the UK Government but ultimately entered administration on 5 March 2020. The airline attributed its demise to "significant funding challenges…compounded by the outbreak of coronavirus."
The airline had previously been rescued from insolvency when it was taken over in 2019 by a consortium known as Connect Airways, made up of Virgin Atlantic, Stobart Aviation and hedge fund Cyrus Capital. Flybe also previously benefited from a GBP 30m investment from Connect Airways as part of a UK Government rescue package in January 2020. The Treasury concluded it could not authorise a new loan, as the airline had already mortgaged most of its physical assets to its shareholders, leaving virtually no collateral for it to offer the UK Government.
It is estimated, by the International Air Transport Association, that passenger carriers will lose between USD 63bn and USD 113bn in revenue in 2020 due to the impact of COVID-19. This is an increase from its previous expectation of a loss below USD 30bn.
INSOLVENCY LAW UPDATE
HMRC - CHANGING INSOLVENCY POSITION
On 6 April 2020 new rules are expected to come into force which will impact the order of priority of creditors of companies that enter a formal insolvency procedure after this date.
Whilst HMRC currently has limited priority over floating charge creditors (for a "prescribed part" only), it generally ranks as a non-preferential unsecured creditor for recovering tax debts owed to it. The new rules will elevate HMRC as a creditor with preferential status in respect of certain taxes.
Brown Rudnick Partners Charlotte Møller and Tracy Fisher and Associate Lucy Hartland have written an article on this, examining how the changes may impact the existing framework, other creditors and lending, as well as providing a summary of the UK Government's response to feedback received on the proposed changes.
To read this article, “Out with the old, in with the … older?” please click here.
LMA UPDATE: The EU-UK future relationship - what happens after Brexit?
The LMA has produced a short update on Brexit and the future relationship between the UK and the EU. The update explains which elements of EU law still apply in the UK during the transition period, such as trade and free movement. If the UK and the EU do not reach an agreement on these areas before the end of the transition period on 31 December 2020, the UK will default to a "no deal" situation. At this point, the relevant EU laws will be replicated in UK law via the Withdrawal Agreement.
The update refers to the continued uncertainty until a deal is achieved, suggesting that the "no-deal" guidance issued by the UK and EU Member States remains relevant.