Suspension of liability for wrongful trading

On 26 June 2020, the Corporate Insolvency and Governance Act (the “Act”) entered into force. The Act introduces some very significant reforms to the restructuring and insolvency framework in the UK, and also deals with immediate issues caused by the Covid-19 pandemic. The reforms include both permanent changes such as to moratoriums and temporary measures intended to deal with the consequences of Covid-19.

In an unprecedented move, a key reform temporarily suspends a director’s personal liability under the Act for wrongful trading. When considering the contribution that a director is required to make towards the company’s debts, the court is to now assume that a director is not responsible for any worsening of the financial position of a company or its creditors where the company’s position worsened due to Covid-19.

BACKGROUND

Insolvency legislation on wrongful trading states that directors of a company can become personally liable for the company’s debts where a director knew or ought to have known that there was no reasonable prospect that the company would avoid insolvent liquidation or administration and fails to take every step to minimise potential losses to creditors once there is no reasonable prospect of avoiding insolvency.  A subsequently appointed administrator or liquidator may bring a claim for wrongful trading under the insolvency legislation against such directors.

This means that directors of limited liability companies may become personally liable for certain business debts if they continue to trade when there is no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration.

TEMPORARY MEASURES

The new temporary measures provided for under the Act suspend the personal liability arising from wrongful trading for directors who continue to trade a company through the pandemic with the uncertainty that the company may not be able to avoid insolvency in the future. Liquidators and administrators will therefore not be able to make a claim against an insolvent company’s directors for any losses to the company or its creditors resulting from continued trading while the wrongful trading rules are suspended.

When considering the contribution that a director is required to make towards the company’s debts, on application by a liquidator against a director, when making an assessment of the director’s liability to contribute to the losses of the company, the court is to assume the director is not responsible for any worsening of the financial position of a company or its creditors during the period 1 March 2020 to 30 September 2020. Most notably, there is no requirement to show that the company’s worsening financial position during this relevant period was actually due to Covid-19 in order to apply.

The aim of the suspension is to encourage directors of businesses which have suffered under and been severely hit by the economic turmoil and uncertainty caused by Covid-19 and lockdown measures to try and work through the business’s challenging circumstances without immediately having to file for insolvency.

The temporary measures will affect all main incorporated forms, other bodies and association, whether or not incorporated. Importantly, larger financial institutions, such as insurance companies, banks, overseas companies and payment institutions are excluded from the suspension. A full list of companies that are excluded are listed in the schedules to the Act.

COULD DIRECTORS STILL BE PERSONALLY LIABLE FOR WRONGFUL TRADING? 

Directors may still be personally liable in very limited circumstances as it is not clear whether any circumstances remain in which the court could order contributions from directors for wrongful trading. As the courts are required to assume that a director was not responsible for the worsening of the company’s financial position, it is unclear whether this can be rebutted.  For example, in situations where it is clear that directors had acted fraudulently or recklessly and clearly did cause the worsening of financial position. Additionally, directors may still be ordered to pay compensation for wrongful trading prior to, during or after the relevant period where the worsening of the company’s financial position was not due to Covid-19.

In consideration of previous case law, the courts will largely consider whether the financial position of the company worsened after the directors knew, or ought to have known, that there was no reasonable prospect of the company avoiding insolvency. Typically, the contribution that directors are required to make will not be more than the amount by which the company’s financial position has worsened. An alternative approach was taken in some cases where it was not possible to make an assessment of the worsening of the financial position of the company.

Therefore, it seems clear that the intention of the provisions in the Act is that the courts should not be ordering contribution from directors in relation to the period 1 March 2020 to 30 September 2020.

NEXT STEPS

The temporary changes provided for under the Act most obviously provide some welcome relief for directors, alleviating some pressure and giving them more time to fully assess the impact of measures being introduced to assist the company’s financial position in line with the changing economic climate.

Importantly, directors are however, not free from all personal liability and will continue to face personal liability under the directors’ disqualification regime and the fraudulent trading regime. Additionally, directors’ other fiduciary duties continue to apply and must be followed. Under the directors’ disqualification regime, a director can be disqualified if his/her conduct is considered unfit, and a factor in determining this is the extent to which the person was responsible for the company’s insolvency. Directors could be faced with a compensation order if their actions caused a quantifiable loss to one or more creditors, whilst under the fraudulent trading regime, directors can face criminal proceedings if they knowingly carry on the business of the company with the intent to defraud creditors, with consequences including disqualification, custodial sentence and personal financial liability.

As directors are generally obliged to consider their duties by reference to the company’s shareholders, when directors know, or should know, that the company is or is likely to become insolvent, it is still nevertheless prudent to continue to take into account the interests of the company’s creditors as well. This is because pursuant to statute, directors have a duty to act in the best interest of creditors when a company is insolvent.

For more information, and any guidance or advice on your responsibilities as a director, Cleveland & Co External in-house counselTM, your specialist outsourced legal team, are here to help.

 

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