The temporary amendments to the insolvency laws which are being considered include:
- Suspending the wrongful trading provisions to give company directors greater confidence to use their best endeavours to continue to trade during the crisis, without the threat of personal liability should the company ultimately fall into insolvency.
- Limiting creditors’ ability to present winding-up petitions and introducing a moratorium against creditor action where the company is facing temporary challenges as a result of the COVID-19 crisis.
- Enabling companies to continue buying essential supplies such as energy, raw materials, or broadband services.
- Extending the 10-day moratorium which arises upon the filing by directors of a notice of intention to appoint administrators.
The precise wording of the amendments is yet to be confirmed. In a press release dated 28 March 2020, the government stated that legislation to implement these amendments would be introduced in Parliament at the earliest opportunity, including provisions to enable the changes to be extended if necessary.2
This follows the example of Australia, which has relieved directors of their duty to avoid wrongful trading for a period of six months, meaning that they will not incur personal liability with respect to debts incurred in this period. European countries whose regimes contain a mandatory filing obligation have introduced, in addition to various support measures, limitations on the requirement to place companies in insolvency proceedings. For instance, the duty to file for insolvency has been suspended in Germany until 30 September 20203 and in Spain until the end of the state of emergency declared by the Spanish government.4
The suspension of the wrongful trading rules would represent a significant relaxation of the UK’s insolvency regime given that its introduction in the Insolvency Act 1986 was seen as one of the most important tools to improve the protection available to creditors. The wrongful trading remedy enables the courts to impose unlimited personal liability on directors of an insolvent company who fail to take all steps to minimise losses to creditors at a time when they knew, or ought to have concluded, that the company could not avoid insolvent liquidation. Such a step may often include ceasing to trade so as to avoid incurring further liabilities.
Directors of companies facing financial difficulties are typically advised to act prudently – to ensure that they are monitoring the financial position of the company, reviewing up-to-date financial information and cashflow forecasts, minimising costs where they can, and ensuring that they seek professional advice. The COVID-19 pandemic has put directors in an unprecedented position – how can meaningful cash flow projections be prepared given the significant market uncertainty? How can boards predict whether they will be able to repay new debt that is incurred to deal with a liquidity crisis? How do companies balance the economic logic of reducing head count against the clear policy objective of keeping the population employed?
The suspension of the rules does not make the answers to these questions any easier, but it reduces the concern for directors as to their own personal liability when taking difficult decisions, such as seeking additional funding or using cash reserves to make payments to suppliers, which they may otherwise have avoided. According to news reports, the suspension will apply retrospectively from 1 March 2020 for three months.
In combination with the planned restrictions on the ability of creditors to present winding-up petitions and the 90-day moratorium against creditor action, this should give directors significant breathing space to manage through the current crisis and encourage them to make use of the various support measures put in place such as the COVID-19 Corporate Financing Facility, the Coronavirus Business Interruption Loan Scheme, or the ability to defer VAT payments.
However, directors should be mindful that the rule changes, if implemented, are intended to assist them in continuing to trade through temporary liquidity and operational challenges which resulted from factors beyond their control and not to provide them with a carte blanche. In fact, the government has expressly stated that the existing laws for fraudulent trading and the threat of director disqualification will remain in place to act as an effective deterrent against director misconduct.5 There is an understandable concern in the market that the rule changes may take the pressure off directors who have been continuing to trade companies that were troubled well before COVID-19 had an impact. There is also the potential impact on the dynamic with creditors where, in a “cov lite” era, pressure on directors to comply with their directors’ duties has become one of the few levers that can be applied to precipitate restructuring discussions.
As a starting point, one should be mindful that the proposals have not yet been made law. As a result, the existing rules continue to apply until such time as the amendments are enacted and the detail of any proposals is made public. In addition, the directors’ general duties will continue to be owed to the company even if the described measures come into force.
There is also no suggestion that the director disqualification rules will be modified. Where a company does enter into formal insolvency proceedings, the insolvency officeholder will examine the directors’ conduct over the prior three years, and if the officeholder considers that a director’s conduct makes them unfit to act as director, the officeholder will report to the secretary of state. Directors can be disqualified for a number of reasons, including fraudulent trading or ‘unfit conduct’. Liquidators will equally be able to bring proceedings under the misfeasance provisions for breach of fiduciary or other duty, potentially making directors personally accountable to return funds to the company for losses caused by any misfeasance.
The fraudulent trading regime will also remain in place, meaning that where a company is carried on with the intent to defraud creditors or for any fraudulent purpose, its directors may be held liable for fraudulent trading, which is a criminal offence.
It is as of yet unclear how the government intends to balance the urgent need to equip directors with the necessary tools to survive the COVID-19 crisis with the existing rules, which are intended to protect company stakeholders. However, it is evident that providing some leeway to boards, which recognises the unique challenges they face, is going to be a necessary component to ensure that the various financial support measures that the government is providing for businesses can be utilised to maximum effect.
Reed Smith will continue to provide updates as the situation evolves.
- youtube.com.
- gov.uk.
- bmjv.de.
- Spanish Royal Decree-Law 8/2020.
- gov.uk.
Client Alert 2020-189
