COVID-19: Suspension of wrongful trading rules

01.04.20

Wrongful trading rules, which can result in directors being personally liable for losses incurred as a result of continued trading, are being temporarily suspended in recognition of the large number of businesses being impacted by COVID-19. While this news will be welcomed by businesses across the UK, directors should not be complacent about their responsibilities.

On 28 March, Business Secretary, Alok Sharma, announced changes to UK insolvency law: 

The changes include enabling companies to continue buying supplies, such as energy, raw materials or broadband, while attempting a rescue, and temporarily suspending wrongful trading provisions retrospectively, from 1 March 2020 for three months for company directors so they can continue operating their businesses without the threat of personal liability.

 

What is "wrongful trading" and who does it apply to?

Wrongful trading is an offence under Sections 214 and 246ZB of the Insolvency Act 1986 (the Act).  It applies to directors and (former directors) of companies that have entered into liquidation or administration (which in this article we will refer to as "insolvency proceedings") and who allowed the company to continue to trade when they knew, or ought to have been aware, that the company could not avoid insolvency proceedings.  

 

What is the test for wrongful trading?

Once a director has concluded, or ought to have concluded, that there is no reasonable prospect of the company avoiding insolvency proceedings, they have a duty to take every step that a reasonably diligent person would take to avoid or reduce potential loss to the company’s creditors. 

If they fail do so, then following insolvency proceedings, the insolvency practitioner appointed can seek an order from the court requiring the director to make such contribution to the company’s assets as the court considers appropriate.  

The court's powers of redress for wrongful trading are designed to be compensatory rather than punitive and aims to put the company back into the position it would have been, but for the actions of the director(s).

 

Suspension of wrongful trading 

At present the entire mechanism of the state is focused on dealing with the health and economic impacts of COVID-19 on the country.  As a result, only limited detail has been provided on this proposed change; the law of wrongful trading will be suspended retrospectively from 1 March 2020 until June. All other directors' duties remain will remain in force and be unaffected. 

The UK Government's announcement has been welcomed by the IoD, however, insolvency and restructuring body, R3, highlights some concerns with President Duncan Swift commenting:

"The profession will…have some serious concerns about the Government's plans to suspend wrongful trading. A blanket suspension could risk abuse. The provisions are there for a reason and protect creditors. We do understand that directors may be worried about the consequences of continuing to trade amid the COVID-19 disruption if they're missing debt payments, but good advice from an insolvency practitioner or insolvency lawyer will remove their risk of facing a wrongful trading action." 

 

What you can do to reduce risk

This decision by the UK Government is being heralded as a pro-business move, forming part of its strategy to protect employment.  However, this decision has not necessarily de-risked matters for directors.   A primary reason for this is that the proposed legislation will operate retrospectively, but perhaps more crucially, there has been no general suspension of directors' duties once a company enters into "the zone of insolvency". Therefore, there must surely be risk associated with any decision taken by directors of companies to continue to trade a company while knowing it cannot avoid insolvency proceedings.  This relaxation cannot therefore be regarded as a panacea for directors. 

Our dedicated Restructuring & Advisory team has significant experience and expertise in advising directors on the duties and obligations incumbent upon them, once companies enter into the zone of insolvency.   
To best protect themselves, directors should seek advice from qualified professionals as early as possible.   In the meantime, the tips provided below will help directors to remain compliant with their duties and responsibilities.

 

  • Until these announcements are enacted into law, they have no legal force. Directors should remind themselves of their obligations and stay mindful of the interests of creditors when making decisions. 

 

  • Keep your cashflow under close and continuous review. The most important issue is to monitor your solvency and take action promptly if a problem is identified or appears to be on the horizon.

 

  • Keep contemporaneous records. It can be of significant assistance if your decisions are being reviewed at a later stage and provides clear details of what decisions were made and why.

 

  • Take advice from a restructuring specialist as soon as you have any potential concerns. Even if no action is required now, if problems later arise you can demonstrate that you have behaved appropriately and responsibly.