By Douglas Hawthorn
Coronavirus (COVID-19) has become the key concern for businesses across the full range of industries, in many cases adding further pressure to already-stretched trading situations. This article considers the commercial impact of Coronavirus, the implications of disrupted trade for directors, and steps that businesses can take to protect themselves.
On 28 March, the Government confirmed that the wrongful trading regime for distressed and insolvent companies was to be temporarily relaxed (retrospectively from 1 March). While this will offer some comfort to directors faced with difficult decisions, directors’ duties and certain trading offences remain in place and we would recommend that directors continue to trade very cautiously during this period. This article, and our specific article on Coronavirus and changes to the insolvency regime, reflect this position.
Under normal circumstances, directors of a company owe their duties to the members of that company as a whole. However, where a company is, or is likely to become, insolvent, those duties realign, and the interests of the company’s creditors take priority. Breach of duties to creditors can attract personal liability, disqualification and requirements for the directors to make good improper transfers of assets. These duties will remain in place regardless of the temporary relaxation of the wrongful trading regime and so the ability to say, with reasonable certainty, whether a company is in fact insolvent is, therefore, crucial, particularly as commercial decisions in the interests of creditors may be dramatically different to decisions benefitting members.
Is the company insolvent?
Establishing insolvency is not always a straightforward process. There are two tests: the cashflow test considers whether a company is unable to pay its debts as they fall due, while the balance sheet test looks at whether a company’s liabilities outweigh its assets. The cashflow test is not concerned simply with debts which are presently due, but also with debts falling due from time to time in the reasonably near future. Beyond the ‘reasonably near future’, any attempt to apply the cashflow test will become speculative and, at that point, a comparison of present assets with present and future liabilities becomes the only sensible test for insolvency. A company that meets either or both the cashflow and balance sheet criteria will be deemed insolvent, and risks being placed into administration or wound up.
The application of the balance sheet test requires an evaluation of whether a company has sufficient assets to have a reasonable expectation of meeting all of its liabilities, including prospective and contingent liabilities. This assessment has to be made in the light of the available evidence and circumstances of the particular case. This includes an acknowledgement that the more distant the liabilities, the greater the likelihood that intruding uncertainties will cause a company to fail the balance sheet test.
Wrongful trading and voidable transactions
The wrongful trading regime engages where a company has no reasonable prospect of avoiding insolvent administration or liquidation. Although the regime has been temporarily relaxed, the offence of fraudulent trading (incurring liabilities that the directors know will not be settled before the company enters an insolvency process) remains in place, and knowledge of the company’s solvency will have a direct bearing on any director’s potential liability for that offence.
Certain transactions may also be impugned under the insolvency legislation, including a company entering into transactions preferring one or more of its creditors over others; transactions for no, or insufficient, value; and transactions defrauding creditors. All of these will continue to apply during the wrongful trading suspension window, and require careful analysis on an ongoing basis. Directors’ duties must be assessed on a company-by-company, rather than group, basis.
While uncertainty remains over the scale and duration of the Coronavirus outbreak, directors can take steps to prepare, both on the commercial front and in order to insulate themselves from inadvertent breaches of duty. Well-prepared and well-advised boards occupy a far better position in the event of a company’s insolvency.
Michelmores’ Banking, Restructuring & Insolvency group has extensive experience advising the boards of distressed corporates, including recent work on Stobart, Flybe, Four Seasons Healthcare, Galapagos, Toys ‘R’ Us and Mothercare.
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.