Temporary suspension of wrongful trading provisions due to COVID-19

In the light of the continuing economic crisis caused by the pandemic, the government on Saturday 28 March 2020 announced a hasty and temporary reform of certain parts of the insolvency legislation in order to try to keep suffering businesses out of formal insolvency procedures. The business secretary Alok Sharma has indicated that the provisions of s214 Insolvency Act 1986 (Wrongful Trading) will be suspended. The legislation, which is currently being drafted, is to apply retrospectively from 1 March 2020.

Wrongful trading

Wrongful trading is a statutory offence under section 214 Insolvency Act 1986. Once a company’s directors conclude, or should have concluded, that there is no reasonable prospect of the company avoiding an insolvent liquidation or administration, they have a duty to take every step which a reasonably diligent person would take to minimise potential loss to the company’s creditors. A director failing to comply with this duty can be ordered to contribute to the company’s assets.

The section therefore means that directors who continue to trade when they know, or should have known, that the company could not avoid insolvency put themselves at risk of being held personally liable for its debts. The purpose of the suspension of the section is to allow companies to continue to trade, and to pay staff and suppliers, through the crisis without the directors taking this risk. It is one of a range of measures to be introduced (including, it appears, some form of extended moratorium protection for companies undergoing a restructuring process) to provide companies with extra flexibility to navigate the crisis.

Comment

The removal of an element of risk for directors involves an increase in risk for creditors. While the suspension of the Wrongful Trading provisions may remove a theoretical barrier to companies continuing to trade, in reality suppliers will be keen to protect their own position and may well tighten payment terms in response to that increased risk, requiring payment upfront or support from a personal guarantee.

There is an obvious concern that unscrupulous directors may seek to use the suspension of the legislation to improve their own position at the expense of creditors. There have however been no changes announced to the law relating to misfeasance, directors’ fiduciary duties or fraudulent trading. The message is that all other checks and balances to ensure directors continue to fulfil their legal obligations remain in place.

RELATED:   INSOLVENCY & CORPORATE RECOVERY


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