Corporate Insolvency and Governance Bill: Wrongful trading

On 30 March 2020, following Business Secretary Alok Sharma's announcement that the Government would make changes to enable UK companies undergoing a rescue or restructuring to continue trading, (giving them breathing space that could help them avoid insolvency), we published a short article trailing some of those mooted reforms. The Corporate Insolvency and Governance Bill (CIGB) has now been published, and is expected to pass into law in, or before, week commencing 1 June 2020. In this article, we discuss the changes to the wrongful trading regime.

What is wrongful trading?

Sections 214 and 246ZB of the Insolvency Act 1986 provide that if in the course of the administration or winding up of a company it appears that:

  1. The company has gone into insolvent administration or liquidation;
  2. At some time before the commencement of the administration or winding up, a director (or shadow director) knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent administration or liquidation; and
  3. That person was a director of the company at that time,

the court, on the application of the administrator or liquidator, may declare that that person is liable to make such contribution (if any) to the company’s assets as the court thinks proper.

The facts that a director 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, 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.

Any compensation order made under these sections should be compensatory rather than penal. As a general proposition, the starting point (but not necessarily the endpoint) for determining the level of compensation is the net deficiency suffered by the company in consequence of the wrongful trading (that is to say, how much worse off is the company as a result of the wrongful trading?).

Please note that where the court makes a declaration under sections 214 or 246ZB of the Insolvency Act 1986 the court may (under the Company Directors Disqualification Act 1986), if it thinks fit, also make a disqualification order (of up to 15 years) against the person to whom the declaration relates.

What has changed?

The CIGB provides that in determining 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 period 1 March 2020 to 30 June 2020.

Certain companies, like insurance companies and banks, are excluded from these provisions.

This is not a "Get Out Jail Free" card (although just to be clear, wrongful trading is a civil rather than a criminal offence, so readers should not be too alarmed by that choice of phrase). Firstly, where wrongful trading occurred and caused a net deficiency, prior to 1 March 2020, directors remain liable. Secondly, a panoply of other fiduciary and statutory duties continue to apply and have not been suspended.

Conclusion

This relaxation is welcome, but directors must tread carefully and take appropriate advice. Practitioners are concerned that companies that, even before the COVID-19 pandemic, were in financial difficulty, are not taking appropriate steps to safeguard stakeholders' interests, wrongly believing that the entire regime has been liberalised. That is not the case, so please do take advice.

If you would like to discuss any of the issues raised in this article, please contact Douglas Hawthorn, Sacha Pickering, Karen Williams or Anna Thompson in Michelmores' Restructuring & Insolvency team.

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.