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Wrongful trading to be suspended – What does it really mean?

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The Coronavirus outbreak has had an unprecedented impact on life in the UK (and across the world). Though the UK Government (the “Government”) has, in an attempt to combat the financial impact of the pandemic, introduced significant changes to health, social and economic policies it is inevitable that these policies, with the disruption that they have had- and will continue to have - on businesses across the country, will cause a number of companies to collapse.  

In these exceptional times, directors must ensure that they are aware of their legal duties and the steps that they should take if their company is, or becomes, insolvent. Directors and insolvency practitioners should also be aware of imminent and temporary changes to the insolvency rules in the UK. These changes, which aim to ensure that business are able to stay afloat both during and after the pandemic, were announced by the Department for Business, Energy and Industrial Strategy (the “BEIS”) on 28 March 2020 and relate primarily to wrongful trading and the protection/continuation of supply.

When does a company become insolvent?

It is not always possible to pin-point the exact moment at which a company becomes insolvent though one of the following two tests will typically be applied by a director of a potentially insolvent company:

  1. The “Cash Flow” Test: if a company cannot pay its debts as they fall due, it is likely to be insolvent.
  2. The “Balance Sheet” Test: if a company’s liabilities (including its contingent and prospective liabilities) exceed its assets, it is likely to be insolvent.

Directors’ duties

A director of a solvent company is under duty to act in the best interests of the company and its shareholders. This duty shifts however when a company becomes, or is about to become, insolvent.

In these circumstances, a director must put the interests of the company’s creditors before its shareholders and take reasonable steps to reduce creditor losses. Failing to act could mean that a director will incur personal liability for the company’s debts and/or will have committed an offence.

Wrongful trading

Ordinarily, a director who continues to trade as normal at a time when their company is technically insolvent may be personally liable for wrongful (or even fraudulent) trading. This is, of course, likely to be a real concern for directors in such challenging times as they attempt to pay wages, suppliers, rents and other overheads when their doors are currently closed for business.

However, on 28 March 2020 Alok Sharma, Secretary of State for the BEIS, announced that the Government would be introducing a three-month suspension of the wrongful trading provisions to allow businesses "greater flexibility as they face the current crisis.” The suspension will apply retrospectively from 1 March 2020 and will remove the threat of personal liability under the wrongful trading provisions of the Insolvency Act 1986 (the “Act”) for directors during the pandemic by allowing them to make payments as normal in circumstances where they would otherwise be liable for wrongful trading.

Whilst this news, on the face of it, will likely be welcomed by directors, the reality is that directors should still exercise caution in the manner in which they run their companies as they remain exposed to personal liability in the event of their company failing. Mr Sharma stressed that all other director duties will continue to apply such that directors will still be under a duty to act in the best interests of the company and, where a company is facing insolvency, in the interests of the company’s creditors.

The reality is that whilst the wrongful trading provisions look like they will temporarily suspended, directors may still face personal liability for fraudulent trading (which has a higher evidential threshold than wrongful trading), misfeasance (a claim which can be brought not only by an liquidator/administrator but by creditors themselves) and directors’ disqualification proceedings.

Continuation of supplies

The BEIS has also announced that it will introduce new rules to ensure that companies can continue to purchase essential supplies and raw materials such as gas, electricity and water.

Under the Act, companies which have entered into a formal insolvency process are still able to receive goods and services which enable the company to trade (including utilities such as gas and water) so long as they are paid for.  

The proposed changes therefore seem to suggest that the Act will be extended so that those companies who have not yet entered into a formal insolvency process can continue to receive essential supplies and carry on trading whilst restructuring the business.  

Recommended practical steps

The exact timing for the publication and/or implementation of the changes to the UK’s insolvency regime are not yet clear as Parliament is in recess until 21 April 2020. Whilst the wrongful trading provisions may be temporarily suspended, for the reasons detailed above, it remains as important as ever that directors are seen to be - and are - taking steps to run their companies in the best interest of the company and, where insolvency is looming, in the interests of creditors. We recommend that directors take the following steps:     

Frequent board meetings

The Board should meet (virtually) as often and as regularly as reasonably practicable to review the company’s position. It is important that these meetings are minuted especially in circumstances where the decision-making process is likely to come under greater scrutiny if the company later becomes insolvent. Directors should always be able to demonstrate that they acted reasonably at all times.

Entire business review

It is likely that most – if not all – businesses will need to put plans in place to reduce overall expenditure and flush out any unnecessary or deferrable costs. For example, where offices have been closed, a business may be entitled to a rent moratorium or deferred tax payments. It may also be sensible to review staff costs and consider whether any employees can be placed on furlough, taking advantage of the government’s offer to cover 80% of salaries up to a maximum of £2,500. That said, directors need to be careful in deferring payments and should be able to demonstrate they have acted in the best interests of creditors, if they form the view that in doing so the company will never be able to repay those deferrals, then they should not be taking such steps and instead should be considering insolvency options.

It is also important to ensure that all financial information is kept up to date and that this information is available to all directors. Each director should understand (on a day to day basis) the company’s financial position with regard to, amongst other things, cash flow, future prospects and ability to pay staff/suppliers.

Government announcements

The social and economic landscape in the UK is changing on a daily (if not hourly) basis. It is important that all directors keep abreast of government announcements/schemes in order that they can work out the practical and economic impact of any new schemes on their business.

Professional advice

It is important that directors take professional insolvency advice to ensure that they are acting in accordance with their legal duties. The point at which a company becomes, or is likely to become, insolvent is the point at which directors must ensure that they are doing all they can to reduce loss to the company’s creditors. Obtaining independent financial advice is also important as directors will need to consider whether the company will ultimately survive the pandemic and/or what re-financing options are available to it.

A Court will generally look more favourably on directors who have acted reasonably, especially if they have taken proper advice from solicitors, accountants and other professionals with a view to minimising loss to creditors.

If you have any queries about any issues raised in this blog, please do not hesitate to contact our Business Restructuring and Insolvency Team.

Disclaimer: Anything posted on this blog is for general information only and is not intended to provide legal advice on any general or specific matter. Please refer to our terms and conditions for further information. Please contact the author of the blog if you would like to discuss the issues raised.