COVID-19 – could wrongful trading suspension come back to bite?
In light of the ongoing COVID-19 pandemic, on 28 March 2020, the Government announced the suspension of s.214 of the Insolvency Act 1986. This section imposes personal liability on directors found to have over-traded while a company was insolvent (so-called ‘wrongful trading’).
By removing the risk of personal liability, the Government is providing directors with the personal protection they need to allow their businesses to continue trading through the pandemic. There are, however, likely to be negative consequences arising from the suspension, including for creditors.
S.214 provides that company directors may face personal liability if they do not take every possible step to minimise their company’s debts once it is apparent that there is no reasonable prospect of avoiding an insolvent liquidation. In assessing liability under s.214, the Court is required to identify the point in time when a director ought reasonably to have known that an insolvent liquidation was inevitable. If, after that point, a director took steps to increase, or failed to take steps to minimise, indebtedness, the Court may order the director to make such contribution to the company’s assets as it considers appropriate.
The possibility that a director may be held personally liable for wrongful trading is a fundamental principle of UK insolvency law. S.214 is applied stringently, with the Courts assessing the position with the benefit of hindsight rather than from the perspective of what the director in question actually knew at the time. This stringent application is designed to encourage rapid decision making, thereby protecting creditors and discouraging situations in which directors continue trading in the expectation of being able to save their business.
The suspension applies retrospectively from 1 March 2020, for an initial period of three months. The suspension does not apply to all directors: if the relevant business was in distress before the COVID-19 pandemic, the provisions remain in force.
The Government has stated on multiple occasions in recent weeks that one of its key priorities is to ensure that its efforts to protect public health do not cause the demise of otherwise viable businesses. The clear goal therefore in suspending wrongful trading laws is to provide directors with the personal protection they need to allow their businesses to continue trading in order to ride out the pandemic. Rather than immediately proceeding to enter into an insolvency process through fear of personal liability, directors of otherwise viable businesses will now be permitted to continue trading through.
The suspension has seen widespread support and provides the necessary environment for some of the Government’s other initiatives to operate within. For example, the suspension of the wrongful trading laws means that directors of otherwise solvent companies will now be able to make use of the Government’s Coronavirus Business Interruption Loan Scheme.
It is, nevertheless, inevitable that disputes will arise as to whether the genesis of businesses’ distresses was the COVID-19 pandemic and whether, therefore, the suspension applies. In addition, the suspension is likely to reduce creditor recoveries for those businesses that enter into an insolvency process in due course when the COVID-19 pandemic comes to an end.
Such issues are unlikely to appear until after the pandemic is over and the wrongful trading requirements are back in place. They will be very fact specific, and inevitably, there will be situations in which misuse by some directors of the relaxation in the rules will emerge – the very reason the provision is there in the first place.