Two wrongs don't make a right - suspension of wrongful trading laws inches closer to the statute book

Two wrongs don't make a right - suspension of wrongful trading laws inches closer to the statute book

The effect of COVID-19 on global dispute resolution - an update on the English Courts

Hot off the press, yesterday we learnt a great deal more about the proposed suspension of the UK’s wrongful trading laws with the publication of the Corporate Insolvency and Governance Bill 2019-21.

News of this development first emerged in March when Business Secretary Alok Sharma announced that the UK’s insolvency framework would be suspended to help struggling businesses dealing with the COVID-19 crisis. However due to the delay in translating this measure to the stature book, what was originally envisaged as a temporary three month suspension of the wrongful trading laws will now apply for a longer period. This is proposed as an initial four month period, with retrospective effect, running from 1 March until 30 June this year – or until one month after the legislation comes into force.  We refer to this period as the ‘Suspension Period’. The Bill contains powers for the Secretary of State to increase the duration of this period by up to six months.

Below we provide an overview of the existing wrongful trading regime, where we are now and what it means for directors of English companies. 

The wrongful trading regime in outline

In summary, the wrongful trading regime aims to discourage directors from continuing to trade a business when it is insolvent at the risk of exposing creditors to greater losses.

The regime applies to current and former directors of a company that goes into insolvent liquidation (section 214 Insolvency Act 1986) or insolvent administration (section 246ZB Insolvency Act 1986). It confers a discretion on the court to impose a liability on such a director to make a contribution to the company’s assets if, prior to the company’s winding up or administration and whilst he or she was in office, he or she knew or ought to have concluded that there was no reasonable prospect that the company would avoid insolvent liquidation or administration.

Directors who face a wrongful trading claim can seek to raise a defence that, even after they knew or ought to have concluded that the company could not avoid insolvent liquidation or administration, they took every step to minimise the potential loss to the company’s creditors. The onus of proving that such steps were taken falls on the relevant director (which is why we recommend that whenever a company is in the zone of insolvency, directors take robust steps properly to minute the rationale for decisions to continue trading and ideally on the basis of external advice).

In practice, claims for wrongful trading by liquidators have been less common than might be expected. Generally speaking, a court is unlikely to make a declaration that a director is liable to make a contribution to the company’s assets unless it is satisfied that, on a net basis, the company is worse off as a result of continuing to trade. The court has a discretion to determine the level of contribution that is required by measuring the increase in the company’s net deficiency of assets during the period between when the directors first realised (or ought to have realised) that there was no reasonable prospect of the company avoiding an insolvent liquidation or administration up to the time when the company entered insolvent liquidation or administration.

Where are we now?

The wrongful trading regime as outlined above is now expected to be suspended on a temporary basis during the Suspension Period. The change will take effect once the Corporate Insolvency and Governance Bill 2019-21 makes its way through Parliament (details of its current status can be found by clicking here).

Once the new law enters force, the effect will be that when considering whether to declare a director liable to contribute to a company’s assets under the wrongful trading provisions, the court will assume that the person is not responsible for any worsening in the company’s financial position incurred during the Suspension Period. There are exclusions for certain companies (such as those which carry on regulated activities under the Financial Services and Markets Act 2000) and bodies such as friendly societies.

But even where the suspension applies, this doesn’t offer a “get out of jail free” card for directors of English companies. Yes, the wrongful trading regime is often cited as the trigger that causes many directors to tip a company into insolvency. Whilst that trigger has gone for the time being (at least in respect of trading activities which take place in the Suspension Period and for those companies that fall within the scope of the proposed new laws), directors are not entirely let off the leash and must still be mindful of a number of other considerations relevant to the continued trading of a business.

For example, directors still owe their fiduciary duties as well as those set out in the Companies Act 2006. Whilst ordinarily these would be owed to the company’s shareholders, this requirement switches when a company is insolvent or at risk of being insolvent so that the directors must take decisions for the benefit of the company’s creditors as a whole.

Moreover, directors still need to be careful that their actions do not fall foul of the following matters:

  • The misfeasance provisions under section 212 of the Insolvency Act 1986
  • The fraudulent trading provisions under section 213 of the Insolvency Act 1986
  • The undervalue provisions under section 238 of the Insolvency Act 1986
  • The unlawful preference provisions under section 239 of the Insolvency Act 1986
  • The directors’ disqualification provisions under section 6 of the Company Directors Disqualification Act 1986
  • Any personal guarantees

It’s beyond the scope of this article to major on how the above might be relevant, but more details can be found by clicking here.

So what does this mean for directors of English companies?

Since the COVID-19 lockdown was announced, many companies have shifted into zombie mode – effectively closing their doors to customers, furloughing a large number of their workforce and temporarily suspending their operations. For many such companies, even without the temporary suspension of the wrongful trading laws, the risks of falling foul of this regime at least in respect of this particular period were likely very small.

However, attention is now starting to turn to resuming business and getting Britain back to work. Many businesses will be weighing up the pros and cons of re-starting their operations. The temporary suspension of the wrongful trading regime will give them a bit of breathing space whilst they do that, but when the Suspension Period ends, many directors will find themselves on somewhat of a cliff edge – do they keep trading or bring down the shutters for good? These are difficult decisions and each situation will have its own peculiarities, but directors will do well to keep the financial performance of their business under close scrutiny and to regularly review that situation as it develops.

And finally…

It would be remiss of us not to mention that the Corporate Insolvency and Governance Bill 2019-21 cited above doesn’t deal with wrongful trading alone. Indeed, insolvency specialists (including our own!) will be salivating over a bill which brings with it a whole wealth of changes to the UK’s existing insolvency regime. We will cover these in more detail in the weeks ahead, but for the time being suffice to say that the Bill also contemplates the following:

  • A new company moratorium, initially for 20 business days but extendable beyond that, to allow struggling businesses to devise a rescue plan
  • A new restructuring plan, sharing many of the characteristics of the existing scheme of arrangement, but allowing for a company’s debts to be re-structured through the injection of rescue finance and enabling cross-class cram-down with the sanction of the court
  • A prohibition on termination clauses in supply contracts being invoked by reason of a company entering into a relevant insolvency procedure
  • Temporary provisions to void statutory demands and restrict winding up petitions made during the Suspension Period

Many of these developments have been on the cards for some time (as we have covered previously here), but COVID-19 has without doubt accelerated their progression to the statute book.  

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