The Corporate Insolvency and Governance Act enacted on 26 June 2020, is the most noteworthy alteration to the UK insolvency framework since the Enterprise Act 2002.
One of the most significant measures in the Act can be found at section 12—the continuation of the temporary suspension of wrongful trading, which was originally introduced in March 2020 at the start of the Covid-19 outbreak in the UK.
This measure allows company directors to ensure that their businesses can weather the Covid-19 storm and continue to operate, without fear of personal liability for wrongful trading.
Although the suspension has significantly reduced the threat of personal liability, company directors must continue to be mindful of other considerations related to the continued trading of their businesses.
What is wrongful trading?
The Insolvency Act 1986 included a number of provisions that protected creditors from the actions of rogue directors.
Specifically, section 214 on wrongful trading required company directors to assess the likely prospect of avoiding insolvency.
Continuing to trade when there was no reasonable prospect of avoiding insolvency can have dire consequences, including personal liability for debts and trading losses.
Furthermore, in certain circumstances creditors could commence direct action against the director and protection of limited liability would not apply.
This is commonly known as ‘piercing the corporate veil’, thus ensuring that in distressed situations directors were acting in the interests of creditors, rather than shareholders.
What’s changed?
>Although the suspension has significantly reduced the threat of personal liability, company directors must continue to be mindful of other considerations related to the continued trading of their businesses.
The Act stipulates that, when considering the input that a director must make towards a company’s debts, the court must now act as though they are not responsible for any worsening of the financial position of the business or its creditors.
For directors who may have previously hurried to start insolvency proceedings and avoid the possibility of any personal liability, the temporary suspension will help postpone many from triggering that process and assist them to emerge intact on the other side of the COVID-19 pandemic.
Directors still have duties
However, despite the government ushering in some much-needed breathing space, directors must be mindful of the fact that all other sources of liability under the Insolvency Act 1986 remain unaffected.
For example, directors will continue to receive sanctions and penalties if they attempt to defraud creditors or the company.
This shows that directors are still bound by their fiduciary duties, and also by the fraudulent trading provisions of section 213.
In addition, directors still have duties under the Companies Act 2006 and must continue to act and be mindful of the interests of creditors if the likelihood of insolvency increases.
Overall, this means that the temporary suspension of wrongful trading doesn’t change the attention that directors should be giving when evaluating the financial position of their company.
Directors’ actions will remain subject to scrutiny, making it critical that they consider very cautiously whether to continue trading if there is not a realistic chance of their company avoiding insolvency.
Continuing to trade when there was no reasonable prospect of avoiding insolvency can have dire consequences, including personal liability for debts and trading losses. Looking forward
With the UK economy enduring its worst quarterly fall in four decades, it is no surprise that the majority of UK businesses are experiencing some form of financial pressure.
While lockdown measures begin to ease and shops and high streets begin to reopen, numerous challenges still lay ahead, particularly with the expected reduction in consumer demand and confidence.
The coming months will likely see a large number of company directors face a challenging ultimatum—should they continue trading or instigate an insolvency process?
From experience, the vast majority of directors understand the difference between steering the business through a challenging period and crossing the line into wrongful trading.
The optimal advice I can give to company directors that are concerned about the financial difficulty they may find themselves in is to continue to consider the needs of all key stakeholders and creditors in any decision.
It is critical that they maintain ‘good housekeeping’ in the form of board meetings and keeping records of actions taken with an assessment of the reasons for certain decisions.
Most importantly, directors shouldn’t be afraid to seek appropriate professional advice and look for external support during this difficult time.
Andrew Knowles is a senior director, restructuring advisory, at Duff & Phelps
