Wrongful trading laws relaxed, but directors’ duties remain
Company directors will have taken some comfort from the recent Government announcement that wrongful trading provisions of the Insolvency Act 1986 (IA 1986) will be relaxed.
However, the details of exactly how the laws will be relaxed are not yet clear, and directors still need to be mindful of their duties under the Companies Act 2006.
When a company is financially distressed and its insolvency looks likely, a director’s duty to promote the company’s success (i.e. acting in the interests of the shareholders as a whole) is replaced by a duty to act in the interests of the company’s creditors, so as to preserve value in the company and maximise the return to creditors.
While it is not an offence to trade while insolvent, directors can face liability for wrongful trading under section 214 IA 1986 if they conclude, or should have concluded, that there is no reasonable prospect of avoiding insolvent administration.
Directors then become liable to make such contribution as a Court determines to the company’s assets so that in turn, the company can repay its creditors. Importantly, directors can be liable for wrongful trading even though the company is not actually trading but its losses are increasing.
How will wrongful trading rules be relaxed?
With much of the UK’s economic activity now effectively paused, the government has proposed a three month temporary suspension of wrongful trading provisions (with effect from 1 March 2020) to allow company directors to continue trading through the pandemic emergency without the threat of personal liability, should the company ultimately fall into insolvency.
Without this suspension many company directors would have been placed in an impossible position and may have been forced to begin insolvency proceedings in respect of the company in order to avoid personal liability.
The changes should allow company directors to continue to pay staff and suppliers even if there are fears that the company will become insolvent. Announcing the changes, Alok Sharma, the UK business secretary, said the move “would allow companies to emerge intact the other side of the Covid-19 pandemic”.
The proposed changes to UK insolvency laws also 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 company supplies to enable them to continue trading during the moratorium; and
- A new restructuring plan binding creditors to that plan, including key safeguards for creditors and suppliers to ensure they are paid while a solution is sought.
Directors’ duties remain
Despite the proposed relaxation, the duties of a director to a company remain in place, and directors need to remain mindful of the following:
- As of yet there are no specific details regarding the proposed rules around wrongful trading. It is unlikely that directors will be given an entirely free rein and that personal liability for wrongful trading will only be relaxed where it can be evidenced that conduct was directly linked to the COVID-19 pandemic;
- Directors are still bound by their fiduciary duties, and also by the fraudulent trading provisions of section 213 IA 1986, which means directors will still be liable if they knowingly attempted to defraud the company or creditors;
- Directors should hold regular board meetings and keep detailed and accurate minutes to evidence that creditors’ interests have been considered;
- Directors should question whether or not taking on new debt to stay solvent at present will benefit the company long-term. This includes accessing government schemes such as the Coronavirus Business Interruption Loan Scheme and the Covid-19 Corporate Financing Facility; and
- Directors’ disqualification rules still apply. If a director or former director of an insolvent company is found to have engaged in conduct which makes him “unfit” for the role, he must be disqualified or have a disqualification undertaking accepted. Other legal provisions will continue to apply – transactions at undervalue, transactions defrauding creditors and preferences, among others.
Company directors still therefore have much to consider. Early engagement with professional advisers can help directors to navigate the legislative framework, access strategic advice and reduce directors’ potential personal liability.