The Suspension of Wrongful Trading: Full Steam Ahead or Proceed with Caution?

The Corporate Insolvency and Governance Bill (“Bill”) was published on 20 May 2020. The overarching objective of the Bill is to provide businesses with the flexibility and breathing space they need to continue trading during this difficult time. The measures introduced by the Bill are designed to help UK companies and other similar entities by easing the burden on businesses and helping them avoid insolvency during this period of economic uncertainty.

One of the measures included in the Bill is the temporary and retrospective suspension of wrongful trading provisions which was announced by Business Secretary, Alok Sharma on 28 March.

The wrongful trading regime

The wrongful trading provisions are contained within sections 214 (liquidation) and 246ZB (administration) of the Insolvency Act 1986. In terms thereof, directors and former directors of a company which has gone into insolvent liquidation or entered insolvent administration (“insolvency proceedings”) may be ordered to make a contribution to the company’s assets to recoup the losses caused by their decision to continue to trade after they knew, or ought to have concluded, that there was no reasonable prospect that the company would avoid insolvency proceedings (“the moment of truth”). However, if the directors can satisfy the court that, from the moment of truth, they took every step with a view to minimising the potential loss to the company’s creditors as they ought to have taken, no such order will be made.

The objective of the suspension

When the suspension of the wrongful trading provisions was announced, the Government indicated that it was to allow directors to keep their businesses going without the threat of personal liability. The announcement generated much discussion around whether the suspension could achieve that objective, whether it was appropriate and whether it was needed at all.

Taking each of those in turn:

The wrongful trading provisions are not the only means by which directors may incur personal liability for their actions. Suspending those provisions alone will not therefore remove the risk of personal liability for directors.

The wrongful trading provisions are there to protect creditors by discouraging directors from incurring liabilities without reasonable prospect of paying them back and consequently any suspension risks abuse.

If directors obtain and follow the advice of an insolvency practitioner or insolvency lawyer the risk of a wrongful trading action being taken by a subsequently appointed administrator or liquidator should be removed.

The legislative provision

Section 10 of the Bill provides that in determining, for the purposes of the wrongful trading provisions outlined above, the contribution (if any) to a company’s assets that it is proper for a person to make, the court is to assume that the person is not responsible for any worsening of the financial position of the company or its creditors that occurs during the relevant period.

Various categories of company (including insurance companies, banks, investment firms and project companies) as well as those carrying on a regulated activity in terms of Part 4A of the Financial Services and Markets Act 2000, together with building societies, friendly societies and credit unions are excluded from the scope of the provision.

The “relevant period” is the period from 1 March 2020 to the later of 30 June 2020 or one month after the coming into force of the Bill. However, that period may be extended for up to 6 months at a time or brought to an end by secondary legislation.

Creditors Beware

Although the suspension of wrongful trading has been introduced as part of a series of measures designed to ease the unprecedented strain which COVID-19 has placed on businesses and their directors, the provision makes no reference to the pandemic. Whereas other temporary provisions in the Bill refer specifically to coronavirus for the purposes of determining their applicability (e.g. the restrictions on winding up petitions), there is no such qualification to the application of the suspension of wrongful trading provision. Indeed, the explanatory notes published alongside the Bill state that there is no requirement to show that the company’s worsening financial position was due to the COVID-19 pandemic. This blanket approach would appear to leave the suspension open to potential abuse and justify the concerns raised following the Government’s announcement back in March.

Directors Beware

It is, however, open to question whether the suspension provision affords directors the protection from wrongful trading actions which the Government intended to give. Whilst the explanatory notes state that the court will not hold a director responsible for any worsening of the financial position of the company or its creditors during the relevant period, and will be unable to declare directors liable to contribute to the company’s assets as a result of losses caused to creditors during the relevant period and subsequent to the moment of truth, this is not reflected in the language used in the Bill. As detailed above, Section 10 of the Bill provides that the court is to assume that the person is not responsible for any worsening of the financial position of the company or its creditors that occurs during the relevant period. From a director’s perspective, there would appear to be the risk of an insolvency practitioner being able to rebut that assumption in the course of an action for wrongful trading.

Full steam ahead or proceed with caution?

The provision may of course be amended as the Bill progresses through Parliament and will, undoubtedly, be subject to the interpretation of the courts in due course. In the meantime, directors should continue to proceed with caution as they try to navigate their businesses through this difficult time. Obtaining and following advice from qualified professionals and complying with their duties and responsibilities will protect directors against the risk of personal liability, whether a claim is made under the wrongful trading provisions, other relevant provisions of the Insolvency Act 1986 (e.g. misfeasance or fraudulent trading) or for breach of duty under the Companies Act 2006.