UK government to temporarily suspend wrongful trading provisions

On 28th March the business secretary, Alok Sharma, announced several new measures to help businesses through the financial impact of Covid:19 so they can emerge intact once the crisis is over.

He said the government’s overriding objective is “to help UK companies which need to undergo a financial rescue or restructuring process to keep trading. These measures will give those firms extra time and space to weather the storm and be ready when the crisis ends.”

Measures include a number of additions to the UK’s corporate insolvency framework:

• a business rescue moratorium to protect companies from creditor action while they consider their options;
• a new court-based restructuring tool; and
• new rules preventing suppliers from cancelling contracts with businesses in an insolvency procedure.

And significantly, there is to be a three-month suspension of the wrongful trading provisions to give directors the confidence to use their best endeavours to continue to trade during the pandemic, without the threat of personal liability, should their attempts to save the company ultimately fail. The suspension will be applied retrospectively from 1 March 2020.

“The government will also temporarily suspend the wrongful trading provisions to give company directors greater confidence to use their best endeavours to continue to trade during this pandemic emergency, without the threat of personal liability should the company ultimately fall into insolvency…Existing laws for fraudulent trading and the threat of director disqualification will continue to act as an effective deterrent against director misconduct.” – BEIS Statement

Further details of the suspension will become clear when the proposed bill is tabled in parliament after the Easter recess.

Under current legislation, a director can be liable if they are found to have continued trading – to the detriment of creditors – at a time when they knew, or ought to have concluded, that there was no reasonable prospect of avoiding a formal insolvency process.

And with a great many directors now struggling to assess the financial viability of their businesses in the face of an unprecedented shock, the wrongful trading suspension will be seen by many as a welcome relief.

But while it may be welcome news for directors, Duncan Swift, president of insolvency body R3, is concerned that that the suspension risks abuse saying that “the provisions are there for a reason and protect creditors”.

From a turnaround and rescue perspective, we don’t think the suspension affects the key question that needs to be asked when a company is deciding whether or not to continue trading; ‘what are the business’s realistic prospects?’. The advice turnaround and rescue professionals should be giving directors remains the same: that it is fine to continue to trade, even if the business is insolvent, so long as the prospects of saving the company are good. This advice hasn’t changed as a result of the new legislation.

So while the proposed measures do not distinguish between businesses that were struggling prior to the coronavirus pandemic and those whose financial performance has been affected only by the pandemic, it should be made clear that the suspension is not a lifeboat to keep afloat companies that were already in difficulty prior to the onset of the pandemic.

The suspension will not allow previously unviable companies to limp on without the threat of personal liability because those that do will be held to account in eventual insolvency proceedings.

And this comes down to the fact that the underlying directors’ duties have not changed. In our recent webinar hosted by Herbert Smith Freehills on 8th April in which the impact of Covid-19 on restructuring, turnaround and insolvency was discussed, this point was emphasised by John Chetwood saying “we can’t forget the underlying directors’ duties”.

As many of our members will know, the reality is that very few directors are actually found guilty of wrongful trading and are far more likely to be found guilty of failing in other duties, yet these temporary measures may bring about a false sense of security.

So, it’s important for turnaround professionals to remind directors that the present challenges and suspension of wrongful trading do not give them a ‘carte blanche’ to disregard their directors’ duties entirely. The suspension of the wrongful trading provisions on its own does nothing to relieve directors of their fiduciary duties or of their duty to exercise due skill, care and diligence as required by the Companies Act. Indeed, it is also necessary for turnaround professionals to be familiar with the Insolvency Act and Company Directors Disqualification Act.

The message to get across to directors is that while wrongful trading may be suspended, this only removes one aspect of a director’s personal liability. As has always been the case, turnaround and rescue practitioners should base their advice on the company’s reasonable prospects. Simply, is there a reasonable chance that the company will recover once the Covid:19 restrictions are lifted?