Coronavirus and changes to the insolvency regime

On 28 March Business Secretary Alok Sharma announced that the Government will make changes to enable UK companies undergoing a rescue or restructure process to continue trading, giving them breathing space that could help them avoid insolvency.

This will include enabling companies to continue buying essential 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 keep their businesses going without the threat of personal liability.

We await clarification on precisely how these broad proposals will be implemented. An update on the Government website elaborated that new restructuring tools will include:

  • A moratorium for companies giving them breathing space from creditors enforcing their debts for a period of time whilst they seek a rescue or restructure.
  • Protection of their supplies to enable them to continue trading during the moratorium.
  • A new restructuring plan, binding creditors to that plan.

All those ideas were mooted in the 2016 insolvency and corporate governance consultation, but momentum for implementing those proposals was, at least until now, lost in the aftermath of Brexit.

The intention regarding the wrongful trading regime is clear, and in the remainder of this article we consider what that change will mean in practice. In short, it's good news for directors facing exceptional challenges, but not carte blanche to switch off.

What is wrongful trading?

A director may be personally liable for wrongful trading if the company has gone into insolvent winding up or administration (i.e. the company’s assets are insufficient to pay its debts and the other liabilities and expenses of the winding up), and he/she: (a) knew or ought to have concluded {based both on his/her actual skill, knowledge and experience and the skill, knowledge and experience which a director in his/her experience ought to have} that there was no reasonable prospect that the company would avoid going into insolvent winding up or administration; and (b) failed thereafter to take every step he/she ought to have taken with a view to minimising the potential loss to the company's creditors.

The facts that a director of a company ought to know or ascertain, the conclusions that he/she ought to reach, and the steps that he/she ought to take are those that would be known or ascertained, or reached or taken, by a reasonably diligent person having both (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and (b) the general knowledge, skill and experience which that director has.

The test is therefore both subjective and objective. For example, a director who is also a qualified accountant will be expected to appreciate financial information in a way that an unqualified director would not.

A director found liable for wrongful trading may be ordered to contribute to the company’s assets for the benefit of creditors. The contribution will normally be the amount of the incremental loss suffered by the company from the time the director knew or ought to have concluded that there was no real prospect that the company would avoid going into insolvent winding up or administration. It has been this prospect of personal liability that has greatly troubled diligent, responsible directors in the flux created by the Coronavirus pandemic.

What does the suspension of the wrongful trading regime mean in practice?

Mr Sharma cautioned that "All of the other checks and balances that help to ensure that directors fulfil their duties properly will remain in force". Directors will therefore remain subject to various duties and obligations, and the suspension of wrongful trading, while welcome, should not be taken by directors as licence to engage in irresponsible conduct.

What are the continuing checks and balances?

There are various duties imposed on company directors by the Companies Act 2006, which codified some of the existing common law and equitable duties. Those duties include:

  • A director of a company must: (a) act in accordance with the company's constitution, and (b) only exercise powers for the purposes for which they are conferred.
  • A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members (but see below) as a whole, including: the likely consequences of any decision in the long term, the interests of the company's employees, and the desirability of the company maintaining a reputation for high standards of business conduct.
  • A director of a company must exercise independent judgment.
  • A director of a company must exercise reasonable care, skill and diligence.

Under the Insolvency Act 1986, offences include:

  • Fraudulent trading (i.e. where it appears that a business has been carried on with the intent to defraud creditors. In order for a claim to be successful, there has to be actual dishonesty, involving real moral blame).
  • Fraud in anticipation of winding up.
  • Transactions defrauding creditors.
  • Misconduct in the course of winding up.
  • Falsification of a company's books.

As a general principle, directors owe their duties to the company to which they are appointed. When a company is solvent, there are a number of statutory interests that a director must take into account when exercising those duties.

A director is required, among other things, to act in a way that he or she considers (in good faith) most likely to promote the success of the company for the benefit of its members (see above). When insolvency becomes likely (i.e. probable), directors must start taking into consideration the interests of creditors.

When a company is insolvent, those interests become paramount; or, put differently, when a director is making decisions which may affect, one way or another, the prospects of its creditors getting paid, it is those creditors' interests which must be considered first and foremost. Given the current economic flux, for many companies and their directors, the necessity of considering the interests of creditors will be engaged.

Conclusion

This is welcome news for directors facing exceptional challenges. However, duties and obligations remain, and directors should be mindful of their content, and continue to act with the utmost care and propriety. Michelmores has a market-leading director advisory practice, and we would welcome the opportunity to speak to your board of directors and to help them to navigate these challenging times.

If you would like to discuss any of the issues raised in this article, or have other concerns about the impact of Coronavirus, please contact Douglas Hawthorn, Charles Maunder, Sacha Pickering or Karen Williams in Michelmores' Restructuring & Insolvency team.

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This article is for information purposes only and is not a substitute for legal advice and should not be relied upon as such. Please contact our specialist lawyers to discuss any issues you are facing.