28 May

As reported in the Financial Times on 25th March, the Government announced (28th March), some important changes to the insolvency laws to protect:

  1. Companies; and 
  2. Directors

The proposed changes to the law is contained in the Corporate Insolvency and Governance Bill and is designed, amongst other things, to protect and preserve viable businesses are as follows:

For information on corporate recovery and insolvency, see Business Essentials.

For CompaniesChanges to the insolvency regime will include new rules that allow companies undergoing restructuring to continue to gain access to supplies and raw materials. They will also be given a time limited moratorium from creditor action, so directors can keep their businesses trading during the pandemic, but without the risk of incurring personal liability.

Details are included in the latest House of Commons Library Briefing Paper (see below).

For Directors: There will be a temporary 3-month suspension of the wrongful trading rules that penalise directors if they allow their company to trade while it is insolvent. 

The suspension will remove the threat of directors incurring personal liability during the COVID 19 pandemic.

This moratorium will be backdated to 1st March 2020, and will mean directors will, subject it is presumed to some safeguards and conditions being imposed, be immunised from legal liability. 

What is Wrongful Trading?

It is a statutory offence under section 214 and section 246ZB of the Insolvency Act 1986. Wrongful trading refers to companies that continue to carry on their daily business trading insolvent, that is, unable to pay their debts as they fall due. 

A director may be liable to contribute personally to the assets of the insolvent company for the benefit of its creditors if:

"..at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation."

In effect, wrongful trading occurs when the director knew or ought to have concluded before the company became insolvent that there was no reasonable prospect of avoiding insolvency yet continued to trade. 

Wrongful trading is where there is no intent to defraud the company’s creditors, but merely a case of poor judgement or a failure on the part of directors to carry out their responsibilities. In other words, wrongful trading does not require dishonesty.

Both wrongful trading and fraudulent trading are offences under the Insolvency Act 1986 and the Companies Act 2006. 

Examples of wrongful trading could include:

  • Entering into credit agreements with a supplier knowing the company will be unable to honour repayment terms
  • Continue to take delivery of stock and goods knowing the company cannot pay for them
  • Deliberately accumulating unreasonably high debt obligations at the detriment to creditors
  • Directors paying themselves an unreasonably high salaries when the company cannot afford them
  • Allowing the accumulation of excessive VAT, NIC or PAYE debts, while spending cash resources for them elsewhere.

It is understood that while the proposed moratorium is in place, directors' other legal responsibilities will remain in place, as the Business Secretary said "all of the other checks and balances that help to ensure directors fulfil their duties properly will remain in force”.

Alok Sharma,  the Business Secretary, in announcing the changes, said:

“Our overriding objective is to help UK companies which need to undergo a financial rescue or restructuring process to keep trading,” he said.

“These measures will give those firms extra time and space to weather the storm and be ready when the crisis ends, whilst ensuring creditors get the best return possible in the circumstances.”

The British Chambers of Commerce have welcomed the initiative- BCC responds to changes to insolvency laws.

Details of the planned insolvency law changes: House of Commons Library

Download the House of Commons Briefing Paper on the changes to the insolvency rules to help business pdf

Professional Commentary:

"The current wrongful trading rules have been of particular concern to directors in recent weeks, given the risk of personal liability for directors if they fail to take every step to minimise potential losses to creditors once there is no reasonable prospect of avoiding an insolvent liquidation/administration, which may push directors to file the company for insolvency proceedings prematurely. Existing laws for fraudulent trading and the threat of director disqualification will remain in force as a deterrent against director misconduct." Kirkland & Ellis

"In general the measures are welcome as part of the Government’s effort to assist UK businesses to survive in unprecedented circumstances. In such times it remains vitally important that directors concerned about their company’s viability should take advice both on the processes available to enable the company to continue trading notwithstanding temporary financial distress and on their own position in relation to the risk of personal liability." Harper Macleod LLP

This blog will be updated when details are released.

By the publications team at: Contracts-Direct.com

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