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COVID-19 and the temporary suspension of wrongful trading

View profile for Jonathan Rathbone
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In recent news which should be welcomed by directors of businesses who are grappling with the impact of COVID-19, it was announced that there would be changes to the insolvency regime. This includes a temporary suspension of wrongful trading provisions for directors to remove the threat of personal liability during COVID-19, with retrospective effect from 01 March 2020.

The Government has offered a range of financial support to businesses, some of which are in the form or grant funding (e.g. the Coronavirus Job Retention Scheme and business rate holidays) and some of which involve borrowing or deferral of payments (e.g. VAT deferral and the Coronavirus Business Interruption Loan Scheme). Where the support involves borrowing or the deferment of payments, the directors of a company need to consider carefully the ability of the company to continue to trade and meet those liabilities when they become due and the directors would normally risk personal liability for wrongful trading. That is made particularly challenging when it is so difficult to predict how long and to what extent a business’s revenue will be impacted by COVID-19.

It would be a significant disincentive for directors to take advantage of the financial support offered by the Government, if ultimately the directors’ faced personal liability if the company eventually went into insolvent liquidation in a worse state than it is now. It is therefore not surprising that the Government has felt the need to temporarily suspend the wrongful trading rules.

Wrongful trading

The Insolvency Act 1986 Act (“Act”) currently provides that, in the event that a company is being wound up or has entered into administration, and it appears that a person who is, or was, a director of the company knew or ought to have concluded at some point before the commencement of the liquidation or administration that there was no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration, the director may be ordered by a Court to make a personal contribution to the company’s assets.

The wrongful trading provisions of the Act require directors to continually assess the financial viability of the company. If it can be determined that, on an objective basis, there is no reasonable prospect that the company can avoid going into insolvent liquidation or insolvent administration, the directors must then take every step to minimise potential loss to creditors and cannot simply avoid the issue by resigning as a director.

The offer of financial help from the government had placed directors in a very difficult position, because, by taking out additional borrowing in an effort to save the business, they could potentially expose themselves to personal liability if it ultimately fails. A claim against directors for wrongful trading is on a net basis and so the directors would be liable only to the extent that the company can be shown to be worse off as a result of the continuation of trading.

The amendment to the Act appears therefore to remove a director's potential personal liability for losses in circumstances when, from 1 March 2020 they knew or ought to have known that the company should enter into a formal insolvency process. As a result, this should allow directors of companies that have been directly impacted by the economic effects of COVID-19 to continue trading.

Directors' continuing duties

It is important to note that whilst there is a suspension of the wrongful trading provisions, directors will still owe duties to their respective companies. Whilst a company is successfully trading, ultimately, these duties are for the benefit of the company's shareholders. Where a company is insolvent, the duty switches so that directors must act in the best interests of the company's creditors as whole.

What does this mean for businesses?

Whilst these proposed measures to relax the wrongful trading provisions are pragmatic steps by the government to alleviate some concerns during this unprecedented period, no indication has been given that claims for other offences under the Act will be suspended. So it is recommended that those involved in the running of a company should continue to seek professional advice if they are concerned about the viability of their business and their personal obligations in these unprecedented times.

Once the government publish the draft legislation, we will provide a further update. In the meantime, please contact Jon Rathbone on jdr@hughes-paddison.co.uk or 01242 574 244 in the Corporate & Commercial department should you need any assistance in the interim.

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